Question

John is 3 years away from retirement. He is currently earning $100,000 per year, and is considering a 1-year training program which has the potential of increasing his wage. Assume John’s personal discount rate is 5%.

If he does not enroll in the training program:

1^st year: his wage is $100,000

2^nd year: his wage will be $105,000

3^rd year: his wage will be $110,000

If he enrolls in the training program:

1^st year: spends $20,000 in tuition

2^nd year: his wage will be $160,000

3^rd year: his wage will be $180,000

What is the present value of his benefits of enrolling in the training program?

What is the present value of his costs of enrolling in the training program?

Which is larger, benefits or costs?

If John becomes more present-oriented than he is now, how may this affect his decision? Explain.

If the government passes legislation delaying the retirement age, how may this affect his decision?

Answer 1

Present Value(PV)= FV(Future Value)/(1+r)ⁿ

Benefits:  1styearPV=100000/(1+0.05)¹--> 100000/1.1025=90703; 2^nd year PV= 105000/1.158=90674; 3^nd year PV= 110000/(1+0.05)³---->110000/1.2159=90468. So the total benefits are 90703+90674+90468=271845.

Costs: 1^st year--- 100000-20000=80000; 2^nd year PV=160000/(1+0.05)¹-------> 160000/1.1025=145125; 3^rd year PV=180000/(1+0.05)²------> 180000/1.158=155440. So the total cost is 80000+145125+155440=380565.   

Costs are larger tham the benefits.

If John becomes more present oriented then he would be spending more by enrolling the training program. And if he does'nt do that then he wil be earning enough profits.

If government passes legislation delaying the retierment age then he can get more benefits and he can even enroll in the training benefits and earn profits in long term.