Chapter Five Household Savings and Investment Decisions Multiple Choice 1.Getting a professional degree can be evaluated as a)a social security decision b)an investment in human capital c)an investment in a consumer durable d)a tax exempt decision Answer:(b) 2.Suppose you will face a tax rate of 20%before and after retirement.The interest rate is 8%. You are 30 years before your retirement date and invest $10,000 to a tax deferred retirement plan.If you choose to withdraw the total accumulated amount at retirement,what will you be left with after paying taxes? a)$51,445 b) $64.000 c) $80,501 d)$100.627 Answer:(c) 3.Suppose you will face a tax rate of 20%before and after retirement.The interest rate is 8%. You are 30 years before your retirement date and have $10,000 to invest.If you invest this in an ordinary savings plan instead of a tax deferred retirement plan,what amount will you have accumulated at retirement? a)$51,445 b)$64.000 c)$80,501 d)$100,627 Answer:(a) 5-1
5-1 Chapter Five Household Savings and Investment Decisions Multiple Choice 1. Getting a professional degree can be evaluated as ________. a) a social security decision b) an investment in human capital c) an investment in a consumer durable d) a tax exempt decision Answer: (b) 2. Suppose you will face a tax rate of 20% before and after retirement. The interest rate is 8%. You are 30 years before your retirement date and invest $10,000 to a tax deferred retirement plan. If you choose to withdraw the total accumulated amount at retirement, what will you be left with after paying taxes? a) $51,445 b) $64,000 c) $80,501 d) $100,627 Answer: (c) 3. Suppose you will face a tax rate of 20% before and after retirement. The interest rate is 8%. You are 30 years before your retirement date and have $10,000 to invest. If you invest this in an ordinary savings plan instead of a tax deferred retirement plan, what amount will you have accumulated at retirement? a) $51,445 b) $64,000 c) $80,501 d) $100,627 Answer: (a)
4.When your tax rate remains unchanged,the benefit of tax deferral can be summarized in the rule,"deferral earns you a)the after-tax rate of return before tax b)the pretax rate of return after tax c)the after-tax rate of return after tax d)the pretax rate of return before tax Answer:(b) 5.From an economic perspective,professional training should be undertaken if the exceeds the a)future value of the benefit;present value of the costs b)present value of the benefits;future value of the costs c)future value of the benefits;future value of the costs d)present value of the benefits;future value of the costs Answer:(d) 6.Suppose you will face a tax rate of 30%before and after retirement.The interest rate is 6%. You are 35 years before your retirement date and $2,000 to a tax deferred retirement plan.If you choose to withdraw the total accumulated amount at retirement,what will you be left with after paying taxes? a)$7,532 b)$10,760 c)$12,298 d)$15,372 Answer:(b) 7.Kecia is currently thirty years old and she plans to retire at age sixty.She is expected to live to age eighty-five.Her labor income is $45,000 per year and she intends to maintain a constant level of real consumption spending over the next fifty-five years.Assuming a real interest rate of 4%per year,no taxes,and no growth in real labor income,what is the value of Kecia's human capital? a) $31,797 b)$35,196 c)$778,141 d)$994,888 Answer:(c) 5-2
5-2 4. When your tax rate remains unchanged, the benefit of tax deferral can be summarized in the rule, “deferral earns you ________.” a) the after-tax rate of return before tax b) the pretax rate of return after tax c) the after-tax rate of return after tax d) the pretax rate of return before tax Answer: (b) 5. From an economic perspective, professional training should be undertaken if the ________ exceeds the ________. a) future value of the benefit; present value of the costs b) present value of the benefits; future value of the costs c) future value of the benefits; future value of the costs d) present value of the benefits; future value of the costs Answer: (d) 6. Suppose you will face a tax rate of 30% before and after retirement. The interest rate is 6%. You are 35 years before your retirement date and $2,000 to a tax deferred retirement plan. If you choose to withdraw the total accumulated amount at retirement, what will you be left with after paying taxes? a) $7,532 b) $10,760 c) $12,298 d) $15,372 Answer: (b) 7. Kecia is currently thirty years old and she plans to retire at age sixty. She is expected to live to age eighty-five. Her labor income is $45,000 per year and she intends to maintain a constant level of real consumption spending over the next fifty-five years. Assuming a real interest rate of 4% per year, no taxes, and no growth in real labor income, what is the value of Kecia’s human capital? a) $31,797 b) $35,196 c) $778,141 d) $994,888 Answer: (c)
8.Kecia is currently thirty years old and she plans to retire at age sixty.She is expected to live to age eighty-five.Her labor income is $45,000 per year and she intends to maintain a constant level of real consumption spending over the next fifty-five years.Assuming a real interest rate of 4%per year,no taxes,and no growth in real labor income,what is the value of Kecia's permanent income? a)$31,797 b) $35,196 c) $778,141 d)$994,888 Answer:(b) 9.Oscar is currently thirty-five year old,plans to retire at age sixty-five,and to live to age eighty-five.His labor income is $40,000 per year,and he intends to maintain a constant level of real consumption spending over the next fifty years.Assuming a real interest rate of 4% per year,no taxes,and no growth in real labor income,what is the value of Oscar's human capital? a)$884,344 b) $691,681 c) $39,999 d)$32,198 Answer:(b) 10.Oscar is currently thirty-five year old,plans to retire at age sixty-five,and to live to age eighty-five.His labor income is $40,000 per year,and he intends to maintain a constant level of real consumption spending over the next fifty years.Assuming a real interest rate of 4% per year,no taxes,and no growth in real labor income,what is the value of Oscar's permanent income? a)$884,344 b) $691.,681 c) $39.999 d) $32,198 Answer:(d) 5-3
5-3 8. Kecia is currently thirty years old and she plans to retire at age sixty. She is expected to live to age eighty-five. Her labor income is $45,000 per year and she intends to maintain a constant level of real consumption spending over the next fifty-five years. Assuming a real interest rate of 4% per year, no taxes, and no growth in real labor income, what is the value of Kecia’s permanent income? a) $31,797 b) $35,196 c) $778,141 d) $994,888 Answer: (b) 9. Oscar is currently thirty-five year old, plans to retire at age sixty-five, and to live to age eighty-five. His labor income is $40,000 per year, and he intends to maintain a constant level of real consumption spending over the next fifty years. Assuming a real interest rate of 4% per year, no taxes, and no growth in real labor income, what is the value of Oscar’s human capital? a) $884,344 b) $691,681 c) $39,999 d) $32,198 Answer: (b) 10. Oscar is currently thirty-five year old, plans to retire at age sixty-five, and to live to age eighty-five. His labor income is $40,000 per year, and he intends to maintain a constant level of real consumption spending over the next fifty years. Assuming a real interest rate of 4% per year, no taxes, and no growth in real labor income, what is the value of Oscar’s permanent income? a) $884,344 b) $691,681 c) $39,999 d) $32,198 Answer: (d)
11.You are currently renting a house for $12,000 per year,and you also have an option to buy it for $240,000.Maintenance and property taxes are estimated to be $4,320,and these costs are included in your rent.Property taxes($2,880 of the $4,320)are deductible for income tax purposes.Your tax rate is 35%.You wish to provide yourself with housing at the lowest present value of cost.If the real after-tax rate is 2.52%,should you rent or buy? a)rent the house;the PV cost of renting is $476,190 b)rent the house;the PV cost of renting is $309,524 c) buy the house;the PV cost of owning is $442,198 d)buy the house;the PV cost of owning is $371,429 Answer:(d) 12.You are currently renting a house for $12,000 per year and you also have an option to buy it for $240,000.Maintenance and property taxes are estimated to be $4,320,and these costs are included in your rent.Property taxes($2,880 of the $4,320)are deductible for income tax purposes.Your tax rate is 35%.You wish to provide yourself with housing at the lowest present value of cost.The real after-tax rate is 2.52%.What is the break-even rent? a)$6,048 b)$9,360 c)$10,128 d)$12,302 Answer:(b) 13.As one gets older,the declines,so falls steadily until it reaches zero at age 65. a)future value of remaining labor income;human capital b)future value of remaining labor income;initial wealth c)present value of remaining labor income;human capital d)present value of initial wealth;optimization Answer:(c) 14.Any lifetime consumption spending plan that satisfies your budget constraint is: a)an optimal model b)a feasible plan c)a model benefit d)a target replacement Answer:(b) 5-4
5-4 11. You are currently renting a house for $12,000 per year, and you also have an option to buy it for $240,000. Maintenance and property taxes are estimated to be $4,320, and these costs are included in your rent. Property taxes ($2,880 of the $4,320) are deductible for income tax purposes. Your tax rate is 35%. You wish to provide yourself with housing at the lowest present value of cost. If the real after-tax rate is 2.52%, should you rent or buy? a) rent the house; the PV cost of renting is $476,190 b) rent the house; the PV cost of renting is $309,524 c) buy the house; the PV cost of owning is $442,198 d) buy the house; the PV cost of owning is $371,429 Answer: (d) 12. You are currently renting a house for $12,000 per year and you also have an option to buy it for $240,000. Maintenance and property taxes are estimated to be $4,320, and these costs are included in your rent. Property taxes ($2,880 of the $4,320) are deductible for income tax purposes. Your tax rate is 35%. You wish to provide yourself with housing at the lowest present value of cost. The real after-tax rate is 2.52%. What is the break-even rent? a) $6,048 b) $9,360 c) $10,128 d) $12,302 Answer: (b) 13. As one gets older, the ________ declines, so ________ falls steadily until it reaches zero at age 65. a) future value of remaining labor income; human capital b) future value of remaining labor income; initial wealth c) present value of remaining labor income; human capital d) present value of initial wealth; optimization Answer: (c) 14. Any lifetime consumption spending plan that satisfies your budget constraint is: a) an optimal model b) a feasible plan c) a model benefit d) a target replacement Answer: (b)
15.There is an advantage to tax deferred retirement savings plans for those when the money is withdrawn. a)who will be in a lower tax bracket b)who will be in the same tax bracket c)both (a)and(b) d)neither (a)nor (b) Answer:(c) Longer Problems 1.Tamara is currently twenty-eight years old,plans to retire at age seventy and to live to age ninety.Her labor income is $50,000 per year,and she intends to maintain a constant level of real consumption spending over the next sixty-two years.Assume no taxes,no growth in real labor income and a real interest rate of 4%per year. (a)What is the value of Tamara's human capital? (b)What is the value of Tamara's permanent income? Answer: (a)N PV FV PMT Result 42 2 2 S50.000 PV= SL,009,281 (b)N PV FV PMT Result 62 S1,009,281 0 PMT= S44,261 The value of Tamara's human capital is $1,009,281 The value of Tamara's permanent income is $44,261 2.You have just turned twenty-eight years of age and feel it is necessary to upgrade your qualifications.After some consideration,you feel that undertaking full-time study for an MBA degree is one alternative.For the two years of full-time study,tuition and living expenses will be $25,000 per year.In addition,you will have to give up your current job with a salary of $35,000 per year.Assume all cash flows occur at the end of the year.Assume a real interest rate of 4%per year,ignoring taxes.Also assume that the salary increase is at a constant real amount that starts after you complete your degree (at the end of the year following graduation)and lasts until retirement at age sixty-five.In order to justify the investment,by how much does your salary have to increase as a result of getting the MBA degree? Answer: Find the FV of tuition and foregone salary at the end of two years: PV FV PMT Result 2 4 0 2 60,000 FV=S122.400 Find the increase in salary that has this amount as its PV: 5-5
5-5 15. There is an advantage to tax deferred retirement savings plans for those ________ when the money is withdrawn. a) who will be in a lower tax bracket b) who will be in the same tax bracket c) both (a) and (b) d) neither (a) nor (b) Answer: (c) Longer Problems 1. Tamara is currently twenty-eight years old, plans to retire at age seventy and to live to age ninety. Her labor income is $50,000 per year, and she intends to maintain a constant level of real consumption spending over the next sixty-two years. Assume no taxes, no growth in real labor income and a real interest rate of 4% per year. (a) What is the value of Tamara’s human capital? (b) What is the value of Tamara’s permanent income? Answer: (a) N I PV FV PMT Result 42 4 ? 0 $50,000 PV = $1,009,281 (b) N I PV FV PMT Result 62 4 $1,009,281 0 ? PMT = $44,261 The value of Tamara’s human capital is $1,009,281 The value of Tamara’s permanent income is $44,261 2. You have just turned twenty-eight years of age and feel it is necessary to upgrade your qualifications. After some consideration, you feel that undertaking full-time study for an MBA degree is one alternative. For the two years of full-time study, tuition and living expenses will be $25,000 per year. In addition, you will have to give up your current job with a salary of $35,000 per year. Assume all cash flows occur at the end of the year. Assume a real interest rate of 4% per year, ignoring taxes. Also assume that the salary increase is at a constant real amount that starts after you complete your degree (at the end of the year following graduation) and lasts until retirement at age sixty-five. In order to justify the investment, by how much does your salary have to increase as a result of getting the MBA degree? Answer: Find the FV of tuition and foregone salary at the end of two years: N i PV FV PMT Result________ 2 4 0 ? 60,000 FV = $122,400 Find the increase in salary that has this amount as its PV: