Your child (John) has come to you for advice. He is about to enter college and h

Question

Your child (John) has come to you for advice. He is about to enter college and has two options open to him. His first option is to study petroleum engineering. If he does this, his undergraduate degree would cost him $20,000 a year for four years. Having obtained this, he would need to gain two years of practical experience: in the first year he would earn $50,000, in the second year he would earn $60,000. He would then need to obtain his master’s degree, which will cost $25,000 a year for two years. After that he will be fully qualified and can earn $80,000 per year for 30 years.

His other alternative is to study finance. If he does this, he would pay $10,000 a year for four years and then he would earn $60,000 per year for 32 years.

The effort involved in the two careers is the same, so he is only interested in the earnings the jobs provide. All earnings and costs are paid at the end of the year. What advice would you give him if the market interest rate is 4 percent? A day later he comes back and says he took your advice, but in fact, the market interest rate was 6 percent. Will you advise him differently and if so why? (show using a financial calculator, step by step)

Explanation / Answer

1. When Market Interest Rate is 4%

Since the present value of cash flows is more in Studying Petroleum Engineering. Thus, John should go for Petroleum Engineering.

2. When Market Interest Rate is 6%

Still the present value is more in case of Petroleum Engineering. Thus, John should do Petroleum Engineering.

Study Petroleum Engineering Study Finance Year Cash Flow PVF Present Value Year Cash Flow PVF Present Value 1 -20,000 0.962 -19,230.77 1 -10,000 0.962 -9,615.38 2 -20,000 0.925 -18,491.12 2 -10,000 0.925 -9,245.56 3 -20,000 0.889 -17,779.93 3 -10,000 0.889 -8,889.96 4 -20,000 0.855 -17,096.08 4 -10,000 0.855 -8,548.04 5 50,000 0.822 41,096.36 5 60,000 0.822 49,315.63 6 60,000 0.790 47,418.87 6 60,000 0.790 47,418.87 7 -25,000 0.760 -18,997.95 7 60,000 0.760 45,595.07 8 -25,000 0.731 -18,267.26 8 60,000 0.731 43,841.41 9 80,000 0.703 56,206.94 9 60,000 0.703 42,155.20 10 80,000 0.676 54,045.13 10 60,000 0.676 40,533.85 11 80,000 0.650 51,966.47 11 60,000 0.650 38,974.86 12 80,000 0.625 49,967.76 12 60,000 0.625 37,475.82 13 80,000 0.601 48,045.93 13 60,000 0.601 36,034.45 14 80,000 0.577 46,198.01 14 60,000 0.577 34,648.50 15 80,000 0.555 44,421.16 15 60,000 0.555 33,315.87 16 80,000 0.534 42,712.65 16 60,000 0.534 32,034.49 17 80,000 0.513 41,069.86 17 60,000 0.513 30,802.39 18 80,000 0.494 39,490.25 18 60,000 0.494 29,617.69 19 80,000 0.475 37,971.39 19 60,000 0.475 28,478.55 20 80,000 0.456 36,510.96 20 60,000 0.456 27,383.22 21 80,000 0.439 35,106.69 21 60,000 0.439 26,330.02 22 80,000 0.422 33,756.43 22 60,000 0.422 25,317.32 23 80,000 0.406 32,458.11 23 60,000 0.406 24,343.58 24 80,000 0.390 31,209.72 24 60,000 0.390 23,407.29 25 80,000 0.375 30,009.34 25 60,000 0.375 22,507.01 26 80,000 0.361 28,855.14 26 60,000 0.361 21,641.35 27 80,000 0.347 27,745.33 27 60,000 0.347 20,808.99 28 80,000 0.333 26,678.20 28 60,000 0.333 20,008.65 29 80,000 0.321 25,652.11 29 60,000 0.321 19,239.08 30 80,000 0.308 24,665.49 30 60,000 0.308 18,499.12 31 80,000 0.296 23,716.82 31 60,000 0.296 17,787.62 32 80,000 0.285 22,804.64 32 60,000 0.285 17,103.48 33 80,000 0.274 21,927.53 33 60,000 0.274 16,445.65 34 80,000 0.264 21,084.17 34 60,000 0.264 15,813.13 35 80,000 0.253 20,273.24 35 60,000 0.253 15,204.93 36 80,000 0.244 19,493.50 36 60,000 0.244 14,620.12 37 80,000 0.234 18,743.75 Total 880,404.25 38 80,000 0.225 18,022.83 Total 989,461.67

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