Is a university degree a good investment? What are the financial returns from a degree? Are some degrees a better investment than others?

Two UK studies have attempted to answer these questions. Both have involved the accountancy firm PriceWaterhouseCoopers [PWC]. The first was commissioned by the Royal Society of Chemistry and published in January 2005. The second was commissioned by Universities UK and published in February 2007.

In both reports PWC calculates the value of a degree by treating it as an investment. They measure the costs and benefits of a university degree using the same techniques that accountants use for business investments. An investment involve spending money now for a future return. There is a negative cash flow in an investment’s early years and, hopefully, a positive cash flow in future years.

The investment return from a degree can be calculated in two ways. The first is in terms of the extra cash a graduate earns from having their degree. The calculation is [future returns – investment costs].

The return can also be calculated as a percentage. What percentage return does the graduate get on the money they have invested in earning their degree. The calculation in this case is [future returns/investments costs * 100].

Calculating costs

There are two kinds of costs involved in investing in a degree. The first is out of pocket costs. This is money that students actually have to pay out. PWC include tuition fees paid by the student plus any loans taken out by the student. They do not include day to day living expenses, presumably on the grounds that these would be incurred anyway.

These amounts are usually pretty small compared to the other kind of cost. Opportunity costs are the value of benefits foregone by taking an alternative course of action. When somebody spends three years at university they forego three years earnings. These lost earnings are the opportunity costs of attending university.

Discounted returns

The returns from a degree are taken as the extra after tax earnings that graduates achieve compared to someone of the same age who only has two or more A levels.

Graduates extra earnings over their entire working life are taken into account, but the earnings are discounted using an accounting technique called discounted cash flow. This recognises that money received in the future is worth less than money received now. For example, if we were offered a choice between £1,000 now and £1,000 in twelve months time we could take the £1000 now and invest it to earn interest [say 5%]. At the end of the year it will be worth £1050.

Another way of looking at this is to say that the present value after discounting of £1000 in a years time is only £952 [£952 x 1.05 = £1,000]

Why does this matter when calculating the value of a degree? Well, most people earn more as they get older, with the highest earnings being in the last few years of their working life. In the PWC study the full lifetime income is included, but the later the extra income is received the more it is discounted and the less its present value. For example, thirty years after completing a medical degree a doctor may be earning an extra £60,000 a year after tax compared to someone who only has three A levels and didn’t go to university. Using discounted cash flow and a 5% discount rate that extra £60,000 in 2037 would be discounted back to a present value of only £13,883.

Which is the best degree?

If we look at the table below from the February 2007 study we can see that medicine produces £340,000 of extra after tax earnings over the graduate’s life compared to the miserable wretch with only A levels. That does not seem much but remember these are not the actual extra earnings, but the discounted extra earnings. The actual extra earnings produced would be much more.

We can also see that there are big differences between different degrees. An engineering degree produces a good return, but an arts degree seems hardly worth taking. PWC calculate that the average graduate has extra discounted after tax earnings of £160,000 over their working life.

So is a medical degree is the best investment? PWC took one other factor into account. A medical degree takes at least 5-6 years to complete, compared to three years for a BA at an English university. The longer a degree course takes the higher its opportunity costs. Someone taking a history degree will be earning after three years. The medical student will not begin earning for six years. The medical student is foregoing six years earnings and therefore is investing more in their degree.

PWC calculated the rate of return for each kind of degree using the following calculation.

Discounted after tax lifetime extra earnings / Out of pocket and opportunity cost of degree.

That produces a different league table.

The law degree produces the highest rate of investment return at 17.2%. The doctor only gets a below average return of 11.6% from their degree. This is because it takes longer to complete a medical degree than a law degree. Engineering graduates seem to score well with both measures. Only one thing is unchanged. Arts students still get the worst deal

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