Consider an 18-year old who is about to undertake an investment in college. Suppose a college education begins now and continues for three more years into the future. Suppose this year’s tuition is $20,000 and tuition is expected to increase 7% per year while enrolled. The returns to schooling are in the form of a yearly $25,000 earnings premium (paid at year end) for this person from age 22 through age 67.
A. Calculate the net present value of this investment assuming an interest rate (discount rate) of 2.5%. Be sure to show the formula you use to calculate the net present value. (I have to be able to figure out how you calculated your answer.) Is there a financial payoff from this schooling? Demonstrate and explain.
B. Now suppose there is a 25% probability of failing/dropping out of college during the first year of school; having completed the first year suppose there is a 10% probability of failing/dropping out of college during the second year of school; having completed the second year suppose there is a 2% probability of failing/dropping out of college during the third year of school; having completed the third year suppose there is a 1% probability of failing/dropping out of college during the fourth year of school. If the student leaves college, then (s)he receives only a $1,500 earnings premium from dropout through age 67. Still presuming an interest rate of 2.5%, now what is the expected net present value of this investment? Be sure to show the formula you use to calculate the expected net present value. (I have to be able to figure out how you calculated your answer.) Is there an expected financial payoff from college education?
C. Is a $25,000 yearly earnings premium for a college education realistic? Explain, presenting and interpreting relevant statistical evidence from the BLS website.