Exercise 2: Discounting costs and benefits

You are currently 40 years old (imagine that!) and you expect to work another 25 years before retirement. In your job as a public policy analyst, you are earning $40,000 a year and, unless you take steps to change that, you expect to continue earning that same amount in real terms for the rest of your working career. This is a problem, because while you do have a little savings put aside, just $5,000 in a savings account earning 5% a year nominal interest, you also owe $23,000 on credit cards (you have great credit, as a policy analyst) on which you are paying 18% a year nominal interest. The rate of inflation is just 2%.

(a) Your boss suggests the following option: take a course in benefit-cost analysis at the SPP (you didn't learn it the first time), and she will raise your pay to $45,000 a year. The course will cost you $5,000 tuition up front, plus you will have to miss work without pay for 6 months starting 6 months from now. Your salary would go up starting a year from now.

(b) What is the present value to you of the increased pay you will get from this?