Master in International Management, 2019-2020
UE Finance
Problem set 6: mock exam
This problem set is a mock exam to help you prepare the final exam. You do not have to submit a solution, but it is highly recommended that you try and solve the problems before the tutorial.
Exercise 1 (5 points)
Suppose a friend is just about to graduate from college and is thinking of going on to grad school. She is only interested in making the present value of her income stream as high as possible, and she can borrow and lend at an interest rate of 5%.
If she does not go to grad school she can earn $30,000 a year for the next 45 years. What is the present value of this stream of income?
PV = 533,222.095 (annuity formula)
If she does go to grad school, she has to spend 3 years studying full time (that is, not working) and paying tuition of $20,000 a year. When she gets out, however, she will be able to earn $40,000 a year for 42 years. What is the present value of this part of the decision?
NPV = 547,567.91
What decision should she make? Would your advice be the same if the interest rate were a lot higher?
She should go to grad school first before working.
If the interest rate were a lot higher, the present value of her income stream would be much lower. However, if she can borrow and lend at the same interest rate, NPV when she goes to grad school will be higher than that when she goes straight to work (other factors keep remained). Therefore, my advice will be the same.
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