Your sister 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%.
(1) If she doesn't 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? (Hint: there's an easier way to compute this than adding up 45 payments.)
(2) 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'll be able to earn $40,000 a year for 42 years. What is the present value of this part of the decision?
(3) What decision should she make? Would your advice be the same if the interest rate were a lot higher?
Human Capital Issues are embedded.