Assume that Sam is going to maximize his income for the next 6 years. He has the

Question

Assume that Sam is going to maximize his income for the next 6 years. He has the opportunity to: Attend a local community college which costs him $10,000 per year and it takes two years to complete it. After degree completion, he will earn $28,000 per year. Attend a 4-year college which costs $15,000 per year and takes 4 years to complete. After the degree completion he will earn $80,000 per year. Keep his present job working for $15,000 per year in a local store. (a) Set up Sam’s present value calculation for each of his 3 options, assuming his discount rate is 3%. (b) Which option maximizes his NPV?
(c) Will increasing the discount rate make Sam more or less likely to go? Why.
  

Explanation / Answer

Find the NPV of all the three options

NPV (1) = -10000(1 + 3%)^-1 -10000(1 + 3%)^-2 + 28000(1 + 3%)^-3 + 28000(1 + 3%)^-4 + 28000(1 + 3%)^-5 + 28000(1 + 3%)^-6 = $78,969.51

NPV (2) =  -15000(1 + 3%)^-1 -15000(1 + 3%)^-2 - 15000(1 + 3%)^-3 - 15000(1 + 3%)^-4 + 80000(1 + 3%)^-5 + 80000(1 + 3%)^-6 = $80,250.97

NPV (3) =  15000(1 + 3%)^-1 + 15000(1 + 3%)^-2 + 15000(1 + 3%)^-3 + 15000(1 + 3%)^-4 + 15000(1 + 3%)^-5 + 15000(1 + 3%)^-6 = $81,257.87

Since the NPV of the third option is highest, it maximizes the NPV for Sam

If the discount rate is increased, Sam is less likely to go because it will reduce the discounted future earnings.

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.