A high school graduate has to decide between working and going to college. If he works, he will work for the next 50 years of his life. If he goes to college, he will be in college for 5 years, and then work for 45 years. In this model, the rate of discount that equates the lifetime present value of not going to college and going to college is 8.24% when the cost of each year of college is $15,000, each year of non-college work pays $35,000, and each year of post-college work pays $60,000. For each of the parts below, discuss how the rate of discount that equalizes the two options would change and who would make a different schooling decision based on the change. (Extra credit: Use Excel to show that the rate of return to schooling is 8.24% in the above case, and solve for the rates of discount associated with each of the parts below.)
Calculating the rate of return for each case is straightforward in Excel by using the IRR function.
(a) Each year of college still costs $15,000 and each year of post-college work still pays $60,000, but each year of non-college work now pays $40,000.
(b) Each year of college still costs $15,000 and each year of non-college work still pays $35,000, but each year of post-college work now pays $80,000.
(c) Each year of non-college work and post-college work still pays $35,000 and $60,000 respectively, but now each year of college costs $35,000.
(d) Each year of college still costs $15,000. The first year of non-college work pays $35,000 but then increases by 3 percent each year thereafter. The first year of post-college work pays $60,000 but then increases by 5 percent each year thereafter.