40 Chapter 3: Methodology Discount rate The discount rate is a rate of interest that converts future costs and benefits to present values. For example, $1,000 in higher earnings realized 30 years in the future is worth much less than $1,000 in the present. All future values must therefore be expressed in present value terms in order to compare them with investments (i.e., costs) made today. The selection of an appropriate discount rate, however, can become an arbitrary and controversial undertaking. As suggested in economic theory, the discount rate should reflect the investor’s opportunity cost of capital, i.e., the rate of return one could reasonably expect to obtain from alternative investment schemes. In this study we assume a 4.4% discount rate from the student perspective and a 0.2% discount rate from the perspective of taxpayers. results, expressed in terms of a benefit-cost ratio, rate of return, and payback period. The investment is feasible if returns match or exceed the minimum threshold values; i.e., a benefit-cost ratio greater than 1.0, a rate of return that exceeds the discount rate, and a reasonably short payback period. In Table 3.4, the net higher earnings of students yield a cumulative discounted sum of approximately $37.4 million, the present value of all of the future earnings increments (see the bottom section of Column 4). This may also be interpreted as the gross capital asset value of the students’ higher earnings stream. In effect, the aggregate FY 2021-22 student body is rewarded for its investment in SUNY WCC’s Business program with a capital asset valued at $37.4 million. The Business program’s student costs are shown in Column 5 of Table 3.4, equal to the present value of $10.6 million. Comparing the cost with the present value of benefits yields a student benefit-cost ratio of 3.5 (equal to $37.4 million in benefits divided by $10.6 million in costs). Another way to compare the same benefits stream and associated cost is to compute the rate of return. The rate of return indicates the interest rate that a bank would have to pay a depositor to yield an equally attractive stream of future payments.40 Table 3.4 shows students of the Business program earning average returns of 14.7% on their investment of time and money. This is a favorable return compared, for example, to approximately 1% on a standard bank savings account, or 9.6% on stocks and bonds (30-year average return). Note that returns reported in this study are real returns, not nominal. When a bank promises to pay a certain rate of interest on a savings account, it employs an implicitly nominal rate. Bonds operate in a similar manner. If it turns out that the inflation rate 40 Rates of return are computed using the familiar internal rate-of-return calculation. Note that, with a bank deposit or stock market investment, the depositor puts up a principal, receives in return a stream of periodic payments, and then recovers the principal at the end. Someone who invests in education, on the other hand, receives a stream of periodic payments that include the recovery of the principal as part of the periodic payments, but there is no principal recovery at the end. These differences notwithstanding comparable cash flows for both bank and education investors yield the same internal rate of return. SUNY WCC’s Business program students see an average rate of return of 14.7% for their investment of time and money.
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