Mr. Smith has an income of $40,000 this year and $60,000 next year. He can invest in a project that costs $30,000 this year, which generates an income of $36,000 next year. The market interest rate is 10%. What will be his consumption next year, if Mr. Smith invests in the project and consumes $50,000 this year?

Question

Quizplus · Accepted Answer

If Mr. Smith does not invest in the project, he can consume $40,000 this year and $40,000 x (1 + 10%) = $44,000 next year. Therefore, his total consumption over two years will be $84,000.

If Mr. Smith invests in the project, he can consume $50,000 - $30,000 = $20,000 this year. Next year, he will earn $36,000 x (1 - 10%) = $32,400 from the project, in addition to his regular income of $60,000 x (1 + 10%) = $66,000. Therefore, his total income next year will be $32,400 + $66,000 = $98,400.

Given his options, Mr. Smith should choose to invest in the project, which will allow him to consume $20,000 this year and $98,400 - $20,000 = $78,400 next year. Therefore, his consumption next year will be $78,400.

The best choice is B.

Mr Smith Has an Income of $40,000 This Year and $60,000