Question

Sally has a decision to make about what she will do in the next 2 years. she can go to school or go straight into the workforce. if sally immediately starts working, she will earn $20,000 in both years 1 and 2. if she goes to school in year 1, she must pay $5,000, but she would earn $47,500 in year 2. if the interest rate is 5%, calculate the present value for sally if she goes to school and if she does not. does the investment in school make sense? does it make sense if the interest rate is 6% or 4%?

Answer 1

If she starts work now she will earn $40,000 in two years. Borrowing 5000 dollars in year one times a flat 5% interest rate equals a total of 5250 which she would have to repay. Not caclualting for taxes, but based on her gross income, that would leave her with 42, 250 dollars and she would end up ahead by the end of two years. So yes at 4 percent it would also make sense. At 6 percent her payback amount would be 5300 dolloars and she would still end up ahead. But in real life there are taxes and compound interest.