Question

Assume that Snoopy faces two choices: (1) drop out of school to earn $28,000 now and $29,000 in the next time period, or (2) stay in school now (without working) and earn $45,000 in the next time period. Assume that the monetary cost of an additional year of schooling is $3,200. (a) If the interest rate is 2%, should Snoopy invest in the additional year of education if only two time periods are involved? Why or why not? (b) Do you think your answer might change if the interest rate is less than 2%? (c ) Now assume that three time periods are involved. If Snoopy does not go back to school, he will earn $28,000, $29,000, and $29,800 in the three time periods, respectively. If he attends school another year, he will earn $45,000 next year and $50,000 in the following year. In this case, if the interest rate is 2% should Snoopy invest in the additional year of education? (d) If Snoopy places a high intrinsic value on acquiring more education, how might your answers change to (a) and (c )? (e) How might your answers change to (a) and (c ) if Snoopy is able to maintain a part-time job while he is in school that pays $10,000? (f) Use this example to discuss the four factors that affect the likelihood someone will invest in human capital.

Answer 1

To compare these alternatives we need to use present value concept

Assumption:

Generally cashflows occur at the end of the period but going with language of question which uses words like now,next time etc. we have to assume that cashflows are occurring at the beginning,so the calculations are being done accordingly.

Part a

If he doesn't spend another year in school

His cashflows are

28000 now and 29000 next time period

Hance present value(PV) =28000+ 29000/(1.02) = 56431.37

Now if he attends school for one more year then cash flow will be

-3200 (cost of schooling now) and 45000 next time period

So PV= -3200 + 45000/1.02 = 40917.64

Therefore from monetary point of view he should not  invest another year in school.

Part b

NO the answer won't change whatever may be the interest rate ( provided it is a positive rate ) because Present value at next period will be calculated at same rate in both these alternatives. Let us check it with lower rate say 1%

Alternative 1

PV = 28000 +29000/1.01 =56712

Alternative 2

PV= -3200 +45000/1.01 = 41354 still alternative 1 is better

Part c

If he do3n't go back to school the cashflows will be

28000 now 29000 next year 29800 following year

So PV= 28000 + 29000/1.02 +29800/(1.02)^2 =85074.20

If he goes back to school for another year he will get

-3200 now ( fees of school) 45000 next year and 50000 following year

So PV = -3200 + 45000/1.02 +50000/1.02^2 = 88976.08

From monetary point of view he should invest one more year in school.

Part d

As i mentioned all these decisions made above are from monetary point of view but if snoopy places higher intrinsic value to the education then he should definitely invest another year in school and if we compare PV in part A and part B we will find that higher education will lend higher cashflows in longer future resultingly PVs of these cssh flows would aslo be higher so from monetory point of view also he should spend time in education it will be benificial in long term hence our answer in part A would change but part C would remain same.

Part e

If he gets a part time job with his one year of schooling,his cash flows for two time periods would be

10000 and -3200  now 45000 next period

Hence PV

-3200 +10000+ 45000/1.02 =50917.65 still lower than alternative 1

Hence answer in part A remain same

For 3 time periods cashflows are

-3200 and

10000 now 45000 next period 50000 after that

So PV =10000 -3200 +45000/1.02 +50000/1.02 = 98976.08 which is higher again higher than alternative 1 hence answer in part C remain same also

Part f

Four factors that any organisation would consider while investing in human capital is

1) level of knowledge:it depends upon the education, training and experience of an individual , an organisation would prefer a highly educated and experienced candidate for the job

2) cost: a highly educated person would demand higher salary then organisation would think whether a person with a lower qualification can do the same work with the same efficiency then it will prefer that candidate only. And not only salary there are some other costs associated with huma human capital like training cost infrastructure and working environment for the employees the training cost for highly educated person would be lower while the infrastructure cost would be higher because he may demand excellent working conditions.

3) competency of the individual: which means the learning abilities of the the candidate organisation would prefer some one who can learn faster and keep his or her self updated.

4) human capital risks: these are basically derived from the personal traits of the an individual like whether he is influenced by his family colleagues or bosses whether he is having any conflict of interest i.e. he is having any hidden individual goal which are in contrary to the organisational goal.