Question 1.
You are considering whether or not to go to graduate school. Well… there are many things to consider, of course, likethe type of job you would thus get, the opportunity to live in a city or town whose existence you might have disregarded entirely otherwise and, most importantly, the sheer and ecstatic joy of learning! (By now, you might be wondering what I am on and where you can get some – search no further than Durian, a pungent fruit available in Chinatowns across NYC). All right, all this is well and good, but there is also a monetary aspect… Financially, will it be a sound decision? Let’s see.
For the purposes of this exercise, we would suppose there is no inflation.
• The graduate program you are looking at lasts four years;
• The school forbids you to work during the time of program (to leave all your time to studying), but they would give you 10 000$ a year to live on
• The program will allow you to get a job paying 70 000 a year when you get out.
• If you do not go to graduate school (suppose you are just graduating from college), you have a job lined up paying 45 000.
• Your discount rate is 10% (0.1).
a) Is this a good idea financially? That is, does the higher wage when you get out ever compensates for the lower income during grad school? If so, how many years should you work on the job after graduation in order to come up ahead? (don’t forget to discount the future!)
b) What if you have another option: A school which lends you the money, but promises a job at 90 000$ when you get out. Let’s say that the school lends you the 10000$ a year instead, and that repayment is due whenever you want (say, within 20 years), but as soon as you graduate, the loan starts accruing interest at a rate of 10% a year (so you owe 40 000$ on the day of graduation, 44 000$ the next year if you don’t pay anything, etc.). In this case, how many years do you need at 90 000$ for you to come out ahead? If you do come start coming out ahead after a while, do you do so faster than at the free school?
c) We talked to some extent about the issue of debt peonage in class. Even if you come out ahead eventually with the deal in b), is it constraining in away in terms of life plans? If so how?
d) So far, I have assumed that you have all the information (job-wise, etc.) in advance and that you know the information for certain. Of course, life is not so simple and no job is ever entirely guaranteed… So in this case, on what would you base your decision (keeping it on financial considerations for now)? How solid of a basis do you feel this is? Does taking uncertainty into account change the assessment of whether you should take a loan to study or not? If so, how does it change it?
Question 2.
This is partly taken from a court case where one of my colleagues was a witness. Suppose that an employee is terminated without cause and that she sues the company for compensation.
• Her wage used to be 20 000$ a year at the time of termination, and was set to grow at 5% a year.
• Suppose we use the rate of interest as the discount rate, at 3%.
• She still had 8 years to work there, before retirement.
• They gave her severance pay of 5000$
• At retirement, she would have been owed a pension equal to the best year in terms of pay (here, the last year, since the salary grows every year – so, for this one, use the wage rate you calculate at the end of the 8 year period). Let’s assume she would have been projected to receive the pension for 10 years (note that the pension level does not increase at all any of these years)
a) How much should the company compensate her, assuming that they are found to be at fault?
Here again, outline all the steps of your reasoning.