Joel Kwan is a corporate lawyer based in Los Angeles, California. Currently acting as financial/legal associate for Westwood Group, a specialty finance company, Joel focuses on general regulatory compliance, creditor rights and structured finance. Visit his website to learn more.

Sunday, September 12, 2010

How much is your education worth?

Since this is back-to-school time, I thought it would be interesting to look into financial valuations of education programs. It might seem a cynical exercise to do so since such exercises strictly examine the economic benefits and costs, whereas sentimental values of studying in certain fields are omitted.
In introductory finances courses, business students learn various methods to evaluate the value of projects that require investments, have future cash flows and respective levels of financial costs. For instance, a typical valuation problem a business student would get is the implementation of an IT system. The most prevalent method at least in introductory finance courses is the net present value (NPV) method which, in simple terms estimates the value of future cash flows generated by a project and reduces them by a discount rate which is a measure of the cost of using the capital of the project. The amount of initial investment is then reduced by the initial investment. This end result is the NPV and represents an estimated value of the project. Naturally, the NPV must be positive in order to be worthwhile.
Now, a general model to calculate the NPV of an education requires lots of assuming and guessing, but for the purposes of the exercise here are the steps to calculating the net present value of your education. I will also set forth an example with an imaginary person.

#1 Estimate the opportunity cost of attending post-secondary education

Assuming one would at least complete high school education, estimate the kind of revenue you could have earned with only a high school degree from age 14 to age 65.

#2 Estimate the life time income received following higher education

Here you can assume you will work until 65.

#3 Estimate the total lifetime cost of your education

Here you can include everything directly related to school – tuition, books etc…

#4 Use the NPV formula to obtain result

C/d – (K)

C = lifetime value derived from higher education (step 2)

D = risk-free discount rate (suggested by US census bureau*) may be found

K= opportunity cost of attending post-secondary education (step 1)
The lifetime cost of your education

* Kantrowitz, Marc. “The Financial Value of a Higher Education” NAFSAA Journal of Student Financial Aid, Vol. 37, No. 1, 2007.

Table from Kantrowitz

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