Sally Has to Decide Between the Following Two Options

question 68

Essay

Sally has to decide between the following two options:
1)Take out a student loan of $70,000 and study accounting full time for the next three years.The interest on the loan is 4% per year payable annually.The principle to be paid in full after ten years.
"2)Study part time and work part time to earn $15,000 per year for the following six years.
Once Sally graduates she estimates that she will earn $30,000 for the first three years and $40,000 the next four years.
Sally's banker says the market interest for a ten-year horizon is 6%.
Required:
a.Calculate NPV of the ten-year cash flows of the two options.For simplification assume that all cash flows happen at year-end.
b.Based on the NPV which of the two options is better for Sally?
c.What is the primary benefit of leveraging an investment decision? What are two drawbacks to leveraging an investment decision?"

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Definitions:

Marginal Tax Rate

The tax rate applied to the next dollar of taxable income, indicating how much tax will be paid on an additional dollar earned.

Average Tax Rate

The fraction of total income that is paid as taxes, calculated by dividing the total amount of tax paid by the total income.

Income

The money received by an individual or group for work, from investments, or from other sources, often used as an indicator of economic standing.

Marginal Tax Rate

The percentage of tax applied to your next dollar of income, indicating the tax bracket rate for each additional dollar earned.