Question

1. (Calculate with Excel only) Consider Carl, a 26-year-old San Diegan who has just graduated from SDSU with a B.A. in Economics. He has received two job offers, one in San Diego that pays him $40,000/year and another in Miami, Florida that will pay him $44,000/year. He is planning on working in the position, regardless of the location, until he finishes his 20^th year of work. His added monetary costs in Miami will be $2,500 each year and he expects psychic costs totaling $5,000 each year for the first 5 years only. He can borrow/save at a rate of 6%. Using the information provided and assuming all costs and benefits are incurred/accrued at the end of each year determine the following:

1. Calculate the net present value of his migration.

      

2. Calculate the internal rate of return of his migration                                                        (round answer to a whole percent).

3. Based on the NPV and IRR, should he migrate? Why?

Answer 1

Benefits in San Diego = $40000 per year

Benefits in Miami = $44000 per year

Life of work = 20 years

Added cost in Miami  

Monetary = $2500 per year

Psychic cost = $5000 for first 5 year.

a) Net present value of his migration:-

If Carl migrate to Miami then additional benefit received = ( $44000 - $40000) = $4000

Additional cost = $2500 per year and $5000 for first five years

  

Particular	Amount	Present value factor	Present value
Additional benefits	$4,000	11.470	45880
Total
Additional cost
Monetary	$2,500	11.470	28675
Psychic	$5,000	4.212	21060
Total			49735
NPV ( Benefit - Cost)			-3855

b)  IRR is where there is no difference in cost in accepting either of the job locations.

Present value of both the locations will be same.

Additional benefit ( present value factor , r , 20 years) = Monetary cost (PVF , r , 20) + Psychic cost ( PVF , r, 5 years )

At 4% NPV is negative hence to attain the zero NPV point we need to reduce the rate of return.

Lets say rate of return is 2% then NPV = $961.50

Formula = Lower rate +(NPV of lower rate/ NPV of lower rate - NPV of higher rate ) * ( Higher rate - lower rate )

= 2% + ($961.50 / 961.50 + 3855) * ( 4-2)

= 2.4%

IRR of Migration = 2.4%

C)

On the basis of NPV and IRR calculation Migration is not a good options since it has higher present cost as compare to work in San Diego .