Fun with IRR. Suppose you have just graduated from college and are deciding on a career. Your four career options, along with your salary in each of the four earning periods, are displayed in Table 5.3. Assume that any career will only last four periods before retirement.

a. Assume your discount factor δ = 0.95. Interpret this assumption.

b. Find the value of the interest rate r that corresponds to your discount factor.

c. Assuming δ=0.95, calculate the net present value (NPV) of becoming an ophthalmologist and of becoming an accountant. Which career do you prefer?

d. Will the internal rate of return (IRR) for becoming an ophthalmologist as opposed to an accountant be greater or less than your answer to Exercise 11(b)?

e. Now assume δ = 0.6. Calculate both the corresponding interest rate and the net present value (NPV) of becoming an ophthalmologist and of becoming an accountant. Now which job do you prefer?

f. Find the IRR for becoming an ophthalmologist as opposed to an accountant. That is, find a value of r∗ that equates these two NPVs.

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Table 5.3. Career options and salary information for Exercises 11 and 12. Salary Occupation Ophthalmologist Accountant Starving artist Sports superstar Period 0 -5 2 1 15 Period 1 1 3 1 0 Period 2 10 4 1 0 Period 3 12 1 0