Question

In: Finance

A) A worker named Hastings lives for two periods (year 0 and year 1) and has...

A) A worker named Hastings lives for two periods (year 0 and year 1) and has to choose his optimal level of education. He has two choices. He can choose to go to school during year 0, in which case he has no earnings during that period; however, in year 1 he earns $220. Alternatively, he can choose not to go to school, in which case he earns $110 in both periods.

Part1. What is Hastings’ present discounted value (PDV) of lifetime earnings if he chooses not to go to school? Assume a discount rate of 10%.

Part2. What is Hastings’ present discounted value of lifetime earnings if he chooses to go to school in year 0? Assume a discount rate of 10%.

Part3. Given your answers to (1) and (2), should Hastings choose to go to school or not? Why?

Part4. Hastings’ sister Patience also lives 2 periods and if she decides not to go to school she also makes $110 in each period. However, if she decides to go to school, she can work part time and earn $50 in year 0 and then earn $220 in year 1. Patience has a discount rate of 0%. Should Patience attend school or not? Show your work

Solutions

Expert Solution

He lives only for year 0 and 1. So calcultion will be made for 2 years       
(a) If not to go to school, Earnings are $110 in year 0 and year 1      
Discount rate (i)=    10%  
So Present value = Sum of (Future Value/(1+i)^n)      
110/(1+10%)^0 + 110/(1+10%)^1      
210      
      
So present discounted value (PDV) of lifetime earnings if he chooses not to go to school is   $210.00  
      
(b) If go to school, Earnings are $220 in year 1      
Discount rate (i)=    10%  
So Present value = Sum of (Future Value/(1+i)^n)      
220/(1+10%)^1      
200      
      
So present discounted value (PDV) of lifetime earnings if he chooses to go to school is   $200.00  
      
(3) Present value of earnings is more if he chooses not to go to school.       
So he should choose not to go to school.      
      
(4) Patience earnings if not to go school is    $110  
Discount rate (i)=   0%  
      
So Present value = Sum of (Future Value/(1+i)^n)      
110/(1+0%)^0 + 110/(1+0%)^1      
      
220      
      
If go to school, Earnings are $50 in year 0 and $220 in year 1      
So Present value=      
50/(1+0%)^0 + 220/(1+0%)^1      
270      
      
Present value is more in case of go to school.       
So she should choose to go to school      
      
      
(Please thumbs up or post comments if any query)

jeff jeffy answered 4 months ago
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