Question

Enrique lives in rural Ecuador and is finishing his high school. As an outstanding student, he was accepted by the leading private university, University de Quito to study in a two year program on comparative literature and linguistics to become a college teacher. If he goes to university, he will pay a tuition fee of $1000 ($1 = 1 peso) per year (for 2 years). Suppose also that there is a “psychological” cost of $400 associated with moving to the city of Quito, which represents the money equivalent (paid only once in the first period) of leaving his family / girlfriend.

In the first year, Enrique can work in the library of the university and earn $1000 per year, while during the summer of the second year he can do an internship and earn $2000. At the third year, he may start working as a college teacher, where he will earn $4000 per year for the first 2 years of his career. For the sake of this exercise, suppose that we only have 4 periods.

If Enrique refuses to go to University, he will work on the family farm and will earn $1000 per year for the first two years. His father promises him a salary equal of $3000 from the third year. Consider a discount factor of 10%.

1. a) Calculate the expected present value benefits of studying.[7points]

2. b) Calculate the expected present value costs of studying (direct and indirect costs) [7

   points]

3. c) Should Enrique go to the University? [1 points]

Answer 1

a.) The benefits enlisted here are as follows. -

Year 1 = $1000 (library income) = C1

Year 2 = $2000 (internship income) = C2

Year 3 = $4000 (college teacher income) = C3

Year 4 = $4000 (college teacher income) = C4

Discount rate = 10% = r

The present value (PV) of all these benefits can be calculated as follows. -

Hence, the present value of the benefits of higher education is $8300 approx.

b.) The costs are enlisted as follows -

Year 1 = 1000 (tuition fees) + 400 (psychological) + 1000 (farm income) = $2400 = C1

Year 2 = 1000 (Tuition) + 1000 (farm income) = $2000 = C2

Year 3 = 3000 (farm income) = C3

Year 4 = 3000 (farm income) = C4

Discount rate = 10% = r

The present value (PV) of all these benefits can be calculated as follows. -

Hence, the present value of the costs of higher education is $8140 approx.

c.) Enrique should go to the university as the expected present value of the benefits is more than the expected present value of the costs.