Question

I can borrow money at a rate of 8% per year, but that I only earn 2% per year on money I loan. A friend has recently offered me an investment opportunity; if I make a $10,000 investment today, then I will receive a guaranteed $10,500 in one year. I currently have $10,000 in the bank, but I plan on consuming $8,000 – meaning that I only have $2,000 that I could invest. Can/should make the investment? What is the maximum amount I would be willing to borrow to make this investment? How much consumption would I need to be willing to forego to make the investment?

Answer 1

The total return percentage from investment made with friend = ((10500-10000)/10000) * 100 = 5%

1) Investment of 2000$ can be made with friend because the rate of return 5% is more 2% which could be earned from lending to other source

2) Nothing should be borrowed to make this investment becasue the cost of borrowing is 8% which is more than the return of 5%

3) 100% consumption should be foregone to make this investment if consuming the money is not essential. Else invest as much as possible.

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