Question

Problem Two University tuition fees in Quebec are the lowest in Canada and has been among the lowest for the past 20-30 years. Use the human capital model to answer the questions below and assume that initial annual earnings for a CEGEP graduate is $40.000 while the corresponding earnings for a university graduate is $52,000. Further, assume CEGEP students graduate at age 20 (so the time horizon is 45 years) and at that age they decide to start working or continue their studies in university. The interest rate is 5% and university studies last 3 years. a) Calculate the present value (PV) of each option (CEGEP and University), using the assumptions above and assuming that CEGEP wages grow on average by 1.5% per year and university wages grow by 3%)

Answer 1

As per the Human Capital model, workforce/humans cn be seen as a commodity and investment in them via education, training or otherwise, would lead to greater economic returns.

In the given question, we are evaluate if the present value of the earning of both, the CEGEP graduate and university graduate.

Since in both the cases, the salary earned by the graduates is the initial salaryamount(P) which grows at a fixed growth rate (g) every year, it is similar to a case of growing annuity.

The interest rate prevailing, can be considered to be the discount rate(d) used to calculate the present value.

Before we get into the calculations, let us record the data given in the question :

Note : 1. A University graduate will study for 3 more years after CEGEP graduation.

Thus his time horizon of earning income would reduce by 3 years as he would not be earning during the time of university studies.

Thus, his effective time horizon is : CEGEP time horizon - 3 years = 45-3 = 42 years

Calculating the present value

The general formula for calculating the present value of growing annuity is :

i.e. Now we will substitute the values in both the case of CEGEP and University graduates and find the present value :

Present Value of CEGEP Graduate :

= 1142857.14 * [1 -  0.2209]

= 1142857.14 * 0.7791

= $ 890,399.997

= $ 890,400

Present Value of a University Graduate :

= 2600000 * [ 1 - 0.4468 ]

= 2600000 * 0.5532

= $ 1,438,320

Thus we can see that the present value of a university graduate's income ($1,438,320) is more than the present value of CEGEP graduate's income ($ 890,400), thus university education leads to more income.

However, to improve the decision making, cost of university education should also be considered, and Net Present Value for both options can be calculated for better decision making.