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

Yes, you should be investing your money because your friend offering almost return of 5% per annum which is higher than return of 2% you can make on your money.

In this case your friendly is offering=[10,500-10000]=( 500/10,000)= 5% p.a

Your bank is still charging money at the rate of 8% per annum so you should not be borrowing for investment because it will not be beneficial since rate of return is lower than the cost of capital.

You should not be borrowing to invest because it will be costing you money.

You can only let go of consumption if you are able to let go the opportunity cost and make 5 percent instead.