You are a college sophomore who fellow classmates in your free time for extra mo

Question

You are a college sophomore who fellow classmates in your free time for extra money. With your current abilities, you can earn $3,000 per year for the next three years However, suppose you have the option of enhancing your ability to by acquiring special training for $6,000. After paying the fee, the training takes two years to complete, but at the end of this training period, you can earn $16,000 during the third year. While training in your free time, you are unable to continue . At what discount rate would you be indifferent between acquiring and not acquiring the training? You would be indifferent if the discount rate were %______

Explanation / Answer

discount rate = r

Without training:

PV = 3000/(1 + r) + 3000/(1 + r)2 + 3000/(1 + r)3

With training:

PV = -6000 + 16000/(1 + r)3

We would equate these options so that one would be indifferent between them:

13000/(1 + r)3 - (3000/(1 + r) + 3000/(1 + r)2) = 6000

Solve for 'r':

r = 3.6%

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