An individuals utility function is given as U (X) = X 0.5 where X represents the money,
Question:
An individual’s utility function is given as U (X) = X0.5 where X represents the money, he has available for spending in a given time period. This individual has an income of $225 in each time period and he discounts the future at the rate of 0.7. If he invests his up-front cost is 25 and his return in in the next time period is 35.
a) Would this individual consider investing if his investment is financed by borrowing and cost of borrowing is 30%? (Consider two period model to justify your answer)
b) Would this individual consider investing if his investment is financed by current savings? (Use two period model to justify your answer).
c) Would this individual consider investing if his investment is financed by: $10 from current savings and rest of it from borrowing and the cost of borrowing is 30%? (Use two period model to justify your answer).
d) What is the minimum discount rate at which individual will consider investing if his investment is financed by current savings? (Use two period model to justify your answer).
e) Would this individual consider investing if his investment is financed by “saving up” $10 from time period 0 and rest of it from time period 1 and invest in time period 1 and receive returns in period 2. Assume that interest received on saved money is 20% and individual will not save if he is not investing (Use three period model)
f) Would this individual consider investing if his investment is financed by:
- “Saving up” $8 from both time period 0 and time period 1;
- Rest of it from borrowing from time period 1 and invest in time period 1 and receive returns in period 2.
- Assume that interest received on saved money is 20%, at the cost of borrowing is 30%, and individual will not save if he is not investing (Use three period model to justify your answer)
Expert Answer:
a No this individual would not consider investing if his investment is financed by borrowing and cost of borrowing is 30 In two period model the individual will have 225 in period 0 and borrow 75 from ... View the full answer
