Question

James Bennett allocates wealth between youth and old age. He has no cash currently, but will inherit $3000 in his old age. He can lend and borrow at the bank at 18%(i.e. lending $1 in youth will give him $1.18 in old age). He has an investment opportunity that costs $12000 now in his youth and has a payoff of $15000 in his old age. This is the only investment opportunity available to him. What is the most he can consume in his youth?

Answer 1

The most he can consume in his youth is $3000. He can borrow $3000 from the bank at 18% interest, which will give him $3540 in his old age. He can then use the $3000 inheritance to pay back the loan.