Question

Lara allocates wealth between two periods: youth (time 1) and old age (time 2).Currently (in her youth) she has $8,000 in cash. She can borrow and lend at the bankat a rate of 15% between time 1 and time 2 (that is, lending $1 in youth will give her$1.15 in old age). Her only investment opportunity other than the bank is a projectthat costs $5,000 now in her youth and has a payoff of $6,000 in her old age. What isthe most Lara can consume in her old age? Assume Lara cannot consume a negativeamount in her youth.

Answer 1

The second alternative is the one that will allow her to consume more in her old age.

Step-by-step explanation:

Giving the following information:

Lara allocates wealth between two periods: youth (time 1) and old age (time 2).

In her youth, she has $8,000 in cash. She can borrow and lend at the bank at a rate of 15% between time 1 and time 2.

Her only investment opportunity other than the bank is a project that costs $5,000 now in her youth and has a payoff of $6,000 in her old age.

Alternative A:

We will use the final value formula.

FV= Present Value*(1+i)^n

FV= 8000*(1.15)^1= $9200

Alternative B:

Receive $6000

Invest 3000= 3000*(1.15)^1= 3450

Total= $9450

The second alternative is the one that will allow her to consume more in her old age.