Question

Assume that you are deciding whether to acquire a four-year university degree. Your only consideration at this moment is the degree as an investment for yourself. Costs per year are tuition fees of $600 and books at $100.

• If you don’t go to university, you could earn $6000 per year as an acrobat.

• With a university degree, however, you know that you can earn $10,000 per year as an acrobat. Because of the nature of your chosen occupation, your time horizon for the investment decision is exactly 10 years after university; that is, if the investment is to be worthwhile, it must be so within a 10-year period after graduation. The market rate of interest is 5 percent. Would you make the investment in a university degree?

This problem involves calculating the present discounted value of a flow of future earnings. Please assume that you face a 14-year horizon. The first four year are the only opportunity you have to go to university; either you choose to go to university at the beginning of year one or never. After attending university graduation, you have exactly 10 years to work as a university-educated acrobat.

Answer 1

Let us calculate the Present value of alternative 1 i.e. "Not go for university degree"

Annual Income=R=$6000

PV=R*(P/A,5%,14)

PV=R*(P/A,5%,14)=6000*9.898641=$59391.85

Now, we calculate the Present value of alternative 1 i.e. "Go for university degree"

Annual Income=R=$10000

Annual expenditure for degree=600+100=$700

So,

PV =-700*(P/A,5%,4)+10000*(P/F,5%,4)*(P/A,5%,10)

(P/F,0.05,4)=1/(1+0.05)^4=0.822702

PV =-700*3.545951+10000*0.822702*7.721735=$61044.70

We find that PV for alternative 2 is higher. We should investment in university degree.