Question

If offered the choice of $1000 today and $3,000 in 3 years’ time, which option would you choose and why? What are the pieces of information would you need to make an analytical decision?

Answer 1

Whether I choose $1000 today or $3000 after 3 years will depend on the expected interest rate. This is because the present value of $3000 received after 3 years, given an interest rate r, is given by:

Present value if $3000 = 3000 ( 1 - r)³

If this present value is less than $1000, we will prefer $1000 now to $3000 after 3 years.

3000 (1-r)³ = 1000

1 - r = 0.69

r = 1 - 0.69 = 0.31 or 31%

Therefore, if the interest rate is above 31%, we prefer $1000 now to $3000 later.

However, this is the case under normal circumstances. In cases of emergency like health expenses, the money may be required immediately, in which case $1000 today will be preferred irrespective of the interest rate.

answered by: anonymous