Using economic decision theory

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Suppose you are considering either working through school or taking out loans. If you work at a 20 hour job at $15 per hour over 50 weeks per year, you can make $15,000, but it will take 5 years to graduate. Alternatively, you can graduate in four years by taking out four $15,000 loans, over the course of your studies, compounded annually at 6%. All $15,000 sums borrowed or earned will be spent on tuition, books and other education-related expenses, and therefore do not count as take-home pay for the earnings that you will receive after college. Upon graduation, assume that you will earn $57,600 per year and that your lifetime spent working and in school will be 40 years (i.e., you will evaluate years 0 - 39). Over the first ten years you will receive 5% annual increases (that is nine 5% raises), and over the remainder of your career you will receive 2% annual raises. If you take out loans, you must pay 15% of your annual salary towards the loan total, until the balance is repaid. Assume that the first year of college is year zero.

1. How many years will it take to pay back the loan after graduating (estimate to the nearest two decimal places, via interpolation)?

2. What is your non-discounted lifetime take-home pay (income minus loan payments and expenses towards college) in the loan and working scenarios? Note: this will mean that your take-home pay will be $0 as long as you are in school, since you are putting your entire loan or earnings towards college

3. Assuming that you value your money at 7% interest, what is the net present value of your take home pay in both scenarios?

4. Which alternative should you choose, using economic decision theory?

5. Is there any discount rate that would cause you to pick the other alternative, and if so at what rate do you change your investment decision?

6. When comparing your take-home for the loan vs. working scenarios, what is the benefit/cost ratio for taking out the loans instead of working? Assume costs are the extra take-home pay valuations when the working-during-college scenario is greater for each given year and benefits are the extra take-home pay valuations when the take-out-loans scenario is greater for each given year.

7. For your situation personally, does this problem change or inform your perspective on the balance between the amount of loans you are taking out and the amount of work you are doing? Note: you may, but you do not need to disclose whether you are taking out loans and/or working.

Reference no: EM13919382

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