I have a question from Economics class. Q: Mike is going to college full time an
ID: 1094943 • Letter: I
Question
I have a question from Economics class.
Q: Mike is going to college full time and working on campus for 20 hours per week,
earning $11,000 per year. His degree takes five years to complete, and tuition is $10,000
per year. During the first four years, he can take out a student loan for part or all of his
tuition. The year after Mike graduates, the loan begins to incur an interest of 10%
APR. (That is, the bank charges interest as if Mike took out the whole loan on his
graduation day rather than earlier). Mike pays off the loan in 120 monthly payments.
With his college degree, Mike makes $55,000 per year and gets a 10% raise each year for
the first 20 years.
Mike has a personal discount rate of 12%.
How much should Mike borrow? What will his loan payments be? What is the net
present value of college plus 20 years of work?
Thanks.
Explanation / Answer
Earnings of Mike in 5 years of college = $ 55,000
Tution fees = $ 50,000
Earnings of Mike before graduation
Year
earnings
NPV @ 12 percent
1
11,000
9823
2
11,000
8767
3
11,000
7832
4
11,000
6996
5
11,000
6237
Total = 39655
Earnings of Mike after graduation
Year
earnings
Present value @ 12 % discount rate
1
55000
49115
2
60,500
48218.5
3
66,550
47383.6
4
73205
46558.38
5
80,525.5
45657.96
6
88,578.05
44909.07
7
97,435.855
44041.01
8
107179.44
43300.49
9
117897.38
42560.95
10
129687.11
41759.25
11
142655.82
40942.22
12
156921.40
40328.8
13
172613.54
39528.5
14
189874.89
38924.35
15
208862.37
38221.81
16
229748.60
37449.02
17
252723.46
36897.63
18
277995.80
36139.45
19
305795.38
35472.26
20
336374.91
34982.99
Total NPV after graduation = $
832391.3
Sum of NPV before gradation + sum of NPV after graduation = $872046.30
By comparing the tables of mike earnings before graduation and after graduation his suitable loan amount will be the sum of the present value before graduation and the sum of present value at 10th year of earnings after graduation i.e 39,655+41759 = $ 81,414
Year
earnings
NPV @ 12 percent
1
11,000
9823
2
11,000
8767
3
11,000
7832
4
11,000
6996
5
11,000
6237
Total = 39655
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