Question

Net Present Value of Lifetime Earnings You are considering three alternative education – work options:

Option #1 Start work immediately, earning $50,000 in period 1 Earning $52,500 in period 2 Earning $45,000 in period 3

Option #2 Spend $10,000 to attend a post graduate certificate program in period 1 Earning $55,000 in period 2 Earning $65,000 in period 3

Option #3 Spend $15,000 to attend a master’s program in period 1 Spend $15,000 to attend a master’s program in period 2 Earning $75,000 in period 3

Your discount rate is 15%.

What option maximizes your net present value of your lifetime earnings? (show your steps)

Answer 1

• NPV, Option 1 ($) = 50,000 x P/F(15%, 1) + 52,000 x P/F(15%, 2) + 45,000 x P/F(15%, 3)

= 50,000 x 0.8696** + 52,000 x 0.7561** + 45,000 x 0.6575**

= 43,480 + 39,317.2 + 29,587.5

= 112,384.7

• NPV, Option 2 ($) = - 10,000 x P/F(15%, 1) + 55,000 x P/F(15%, 2) + 65,000 x P/F(15%, 3)

= - 10,000 x 0.8696** + 55,000 x 0.7561** + 65,000 x 0.6575**

= - 8,696 + 41,585.5 + 42,737.5

= 75,627

• NPV, Option 3 ($) = - 15,000 x P/F(15%, 1) - 15,000 x P/F(15%, 2) + 75,000 x P/F(15%, 3)

= - 15,000 x 0.8696** - 15,000 x 0.7561** + 75,000 x 0.6575**

= - 13,044 - 11,341.5 + 49,312.5

= 24,927

Since NPV is highest for option 1, this maximizes the NPV of lifetime earnings.From P/F factor table