Many college graduates feel as if their student loan payments drag on forever. S

Question

Many college graduates feel as if their student loan payments drag on forever. Suppose that the government offers the following arrangement: It will pay for your college in its entirety, and in return you will make annual payments until the end of time.

a.    Suppose the government asks for $6,000 each year for all of eternity. If interest rates currently sit at 4%, what is the present value of the payments you will make?

b.    Your college charges $140,000 for four years of quality education. Should you take the government up on its offer to pay for your college? What if your college charged $160,000?

Explanation / Answer

Hi,

Please find the detailed answer as follows:

Part A:

Present Value = Annual Payment/Interest Rate = 6000/(4%) = $150000

Part B:

When College Fee is $140000:

Since the Present Value ($150000) of all the payments is more than the college fee of ($140000), we should not take the government 's offer. It is so because if accept the government's offer, you will have to pay the $150000 in total when infact your total college charges are $140000 only.

When College Fee is $160000:

Since the Present Value ($150000) of all the payments is less than the college fee of ($160000), we should take the government 's offer. It is so because if don't accept the government's offer, you will lose $10000 extra by paying $160000 as against $150000.

Thanks.

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