An individual who is considering consumption between two time periods (year 1 and year 2)has an endowment of $20,000 in year 1 and $15,000 in year 2.If the interest rate is 5 percent,what is the maximum approximate amount that can be spent on consumption in year 1?
A)$35,000
B)$20,000
C)$35,750
D)$34,250

Question

Quizplus · Accepted Answer

The individual can consume the entire $20,000 from year 1 and borrow against the $15,000 from year 2. The present value of $15,000 from year 2 at a 5% interest rate is $15,000 / 1.05 = $14,285.71. Therefore, the maximum amount that can be spent in year 1 is $20,000 + $14,285.71 = $34,285.71, which is approximately $34,250.

An Individual Who Is Considering Consumption Between Two Time Periods