Question

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 interest-bearing 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.

Answer 1

Deal, and the best option is to pay the same amount at the end of the academic year.

The reason for this is that if you have that amount in an interest bearing account, the money will earn interest, meaning that after paying the tuition at the end of the year, you will have the interest earned for yourself.

In other words, the present value of your money is the full value of your tuition, while the future value of your money is the value of the tuition plus the interest earned.

Besides, because the time value of money decreases as time passes, the amount you pay in tuition will represent less of your total income at then end of the academic year, than at the beginning.