Here is the deal: You can pay your college tuition at the beginning of the academic year or the same

Here is the deal: You can pay your college tuition at the beginning of the academic year or the same

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September 3, 2023
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Here is the deal: You can pay your college tuition at the beginning of the academic year or the same amount at the end of the academic year. You either already have the money in an interestbearing account or will have to borrow it. Deal, or no deal? Explain your financial reasoning. Relate your answer to the time-value of money, present value, and future value. LO18.4

Answer and ExplanationSolution by a verified expert

Explanation
The time value of the money implies that money received in the current period holds a higher value compared to the money received in the future. This is because the money received now can be invested and an interest income can be earned on it. Using the same idea, the individual must always pay the tuition fees at the end of the academic year when given the choice. This is true for both the cases where the individual has the tuition fees in the interest-bearing account at the start of the year or has to borrow from somewhere else.

First, the case where the student holds the money in his interest-bearing account is evaluated based on the following assumptions. The student has to pay $5,000 as tuition fees that could either be paid at the start of the academic year or its end. Additionally, the interest rate is assumed to be 10%. When the student holds $5,000 in his account and decides to pay it as fees after the end of the year, one will earn interest income on that amount of $5,000 at the interest rate of 10% during the academic year. Thus, the student would have
$
5
,
000
+
(
0.1
×
$
5
,
000
)
=
$
5
,
500
$5,000+(0.1×$5,000)=$5,500 at the end of the year. Out of $5,500, $5,000 can be paid in fees and the rest of $500 would go in the pocket of the student. On the other hand, if the student would have decided to pay $5,000 at the start, he would have given up the amount of $500 that he could potentially have earned.

Now, if the student has to borrow $5,000, it is still preferred to pay the tuition fees at the year's end. This is because the student can borrow $5,000 at the start of the year, put it in the interest-bearing account, and therefore, would have $5,500 in the account at the end of the year. $5,000 out of this total could be paid as fees and the rest $500 can be saved. Thus, the student can lower the debt burden by $500.

Sample Response
The student would be advised to pay the tuition fees at the end of the academic year in both cases. If one has the money to be paid as a tuition fee in the interest-bearing account at the start of the year and decides to keep them for the academic year, one could earn some interest income. Additionally, even if one has to borrow the money to pay as tuition fee, one could borrow it at the start, keep them in the account during the year, and have more than the tuition fee in an account at the end of the year. Doing so would reduce the debt burden of the student. On the other hand, if the fees are paid at the year's start, there would be no interest income for the student.

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