Question

Suppose you’re considering to career paths:

Work as a grocery store clerk for the 40 years making $1000 a mont.

Go to college in accounting at an additional cost of $400 a month (12 months/ year) for four years. After obtaining your degree you will make $1,400.00 per month the first and second years out of school. You will then quit your job and go get your MBA which will cost you $850.00 per month for 24 months. After obtaining your MBA, you will make 2000 and $500 per month for 32 years.

Sami start working immediately after college and your MBA (because you were smart and started looking for work 9 months before you graduated). Assume that all cash flow’s or at the end of the month and that the applicable interest rate is 9.60% compounded monthly.

A) considering only the cashless, what is the PV of your future earnings if you pursue the grocery store clerk career?

B) considering only cash flows, what is the PV of your future earnings (net of incremental college costs) if you pursue the accounting-MBA career?

Answer 1

(a) Cash Flows at end of each month = P = $1000

Number of months = n = 40*12 = 480

Interest Rate =r = 9.6% = 0.096/12 monthly

Hence, PV = P[1- (1+r)^-n]/r = 1000(1-(1+0.096/12)^-480)/(0.096/12) = $122,271.94

(b) Cash Flows -

Year 1 to 4 College (48 months) = $-400

Year 5 and 6 (24 months) Job = $1400

Year 6 and 7 (24 months) College = $-850

Year 8 onwards (384 months) = $2500

Interest Rate =r = 9.6% = 0.096/12 monthly

Hence, PV = PV (48 months college) + PV(24 months accounting Job) + PV(24 months MBA college) + PV(384 months MBA job)

PV of cash flows = P[1- (1+r)^-n]/r

PV (48 months college) = -400(1-(1+0.096/12)^-48)/(0.096/12) = -$15891.36

PV(24 months accounting Job) = {1400(1-(1+0.096/12)^-24)/(0.096/12) } / (1+0.096/12)⁴⁸ = $20779.62 (discounted by 48 months to current period )

PV(24 months MBA college) = {-850(1-(1+0.096/12)^-24)/(0.096/12) } / (1+0.096/12)⁷² = -$10420.18

PV(384 months MBA college) = {2500(1-(1+0.096/12)^-383)/(0.096/12) } / (1+0.096/12)⁹⁶ = $138604.79

Hence, PV = -15891.36 + 20779.62 - 10420.18 + 138604.79 = $133072.87