Question

Theodore is considering a one-year training program to learn how to install airport screening equipment at Southern Alberta Institute of Technology (SAIT). SAIT charges $20,000 in tuition for the one-year program. If Theodore takes the program, he will also forego his current annual salary of $100,000. However, his employer has promised him a five-year contract earning $130,000 annually. Theodore plans to retire in six years.
Use the above information to answer the questions below

   a) Should Theodore enroll in the program? Why? Assume Theodore's annual 'discount rate' is five per cent (5.0%).

b) Does the answer in a) depend on Theodore's discount rate? Why or why not?

Answer 1

a)

If Theodore did not enroll in the program, then the present value of his current salary at a discount rate of 5% is calculated as below

Present value of current salary = $507,569.21

If Theodore enrolled in the program, the present value of the training, the annual salary foregone from current employer and the annual income he will receive from future employer is calculated as follows

Present value of enrolling in the one year training program = $420,792.35

Thus Theodore should not enroll in the program because the present value of annual salary he will receive from enrolling in program is less than the present value of the current salary.

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b)

The answer in part a does not depend on Theodore's discount rate because even if we use a higher or a lower discount rate, the present value of Theodore current salary will be higher than the annual income he will receive if he undergoes the training program.