Question

Floyd is now working on a job that pays $35,000 per year. He is contemplating a full-time one-year automobile mechanics course that entails costs of $15,000 for books and tuition (Note: he will not be able to work at all while he is studying). Floyd estimates that the course will increase his income to $50,000 in each of the three years following completion of the course. At the end of those three years, Floyd plans to retire to a commune in Boulder, CO. The relevant discount rate is 5 percent. What is the net present value of the educational investment project? Is it economically rational for Floyd to enroll in the course? Explain. Please show your work using spreadsheet software, such as Excel.

Answer 1

Floyd is deciding to take a course of 1 year and then he will work for 3 additional years before retiring. A current job pays a salary of $35000. Leaving the job will imply an opportunity cost of $35000 straightaway. After four years from now, the present value of this opportunity cost is

35000 + 35000/1.05 +35000/1.05^2 + 35000/1.05^3 = $130313.68

Cost of books and tuition is $15000 which at a rate of 5% becomes 15000/1.05 or $14285.71 in present value terms. Hence the total cost of leaving becomes $144599.4

A salary of $50000 will be received after one year from now and will be received for three years then. Its present value is

50000/1.05 + 50000/1.05^2 + 50000/1.05^3 =$136162.4

Since the new salary received will be having a less present value than the present value of cost, the course is not rational