Quote:
Originally Posted by 1leggedballer
ha I have this for a econ paper lol
|
that's a ****ty question for an econ paper.
And it's just a ****ty question. There are so many options that can be based in many different assumptions you might make. Anyway -
If you had 10,000 dollars spending it on an asset might be considered an investment if that asset can make a greater return than its cost.
If you had 10,000 dollars you might want to invest it in securities.
If you had 10,000 dollars, you might take out a loan, buy something now, and invest the 10,000 you have in securities or put it in a savings account depending on the amount of risk you are willing to take on and expected return based on current market conditions.
If you had 10,000 dollars you might simply spend all of it if it means little to you to have 10,000 dollars or if you are not looking to increase your total wealth.
If you are simply looking to increase your wealth than you must do differential analysis of the NPV of each decision which will allow you to choose the decision which will increase your wealth by the greatest amount proportional to the amount of risk you are undertaking. This is typically called the "opportunity cost" of your decision. If the opportunity cost of one decision is less than another it is advisable to take the decision with lower opportunity costs.
Well go over each possibility with simplified explanations in order to better understand how one can make decisions.
1) If you don't currently have a car you might work at a job close to your house or close to a bus route. This job (Job A) might currently pay 8.00 per hour. But, you see on craigslist that you can get a job (Job B) paying 20.00 per hour, but you need a car. We'll use the current discount rate of 1.75% to evaluate NPV. Hours per week is 40, 52 weeks per year, yearly wage (if you worked everyday of the year, since we'll assume you'd work the same number of days so it is irrelevant how many days you actually worked) of 16440 for Job A, and Job B is 41,600. We'll also make the assumption that buying a car at 10,000 dollars will give you the best reliability at the lowest cost. So lets evaluate how spending the 10,000 initially is actually a positive investment. We'll estimate gas will cost approximately 3,000 per year.
For Job A, you are required to make no investment. You walk back and forth to work everyday with no problems. So, your total Revenue for 1 year will be 16440 (discount taxes as it only complicates the situation). We'll also simplify by saying you get paid in one lump sum at the end of the year since incorporating cash flow and compounding of interest etc... would only further complicate the problem. So you make 16440 per year at Job A. We then discount that by 1.0175 to find the PV of 16440. So the PV of 16440 is 16157 (when rounded to the nearest whole number). the NPV of Job A is 16157. If you take job B you'll make 41,600 dollars. The PV of 41,600 dollars is 40885 dollars. Subtract 10,000 dollars for the cost of the car the your NPV of Job B is 30,885 dollars per year. So we see that the initial investment of 10,000 dollars still yielded a positive differential NPV of 14728 dollars.
2) Ok, so we see how acquiring an asset can be used to increase wealth by allowing you to take another Job which has higher payment that covers and exceeds the cost of the initial investment as well as the opportunity cost of quitting your current job that makes just 8.00 per hour. But, what if, instead of quitting your current Job at 8.00 an hour and buying a car worth 10,000 dollars, you could invest that 10,000 and generate a higher rate of return on that 10,000 dollars in one year that was greater than the return you would get if you took Job B. See, because when you saw the Job B listing, the hourly wage was misstated. Instead of 20.00 per hour you only made 15.00 per hour. At this wage rate you still yield a positive NPV of 5025.
If you, however, determined through information you had, that the NPV of investing and keeping your current job - purchasing a new car and taking Job B at 15.00 per hour was greater than 5025 (in one year) than you should choose to go with the investment. However there is more risk involved in an investment. If you determine that the risk (risk is determined by using historical data to determine the variance of return rates of a portfolio) is too great because you do not currently hold a strong financial position you may choose still to take Job B since you have determined you cannot afford to take on a high amount of risk that NPV may not exceed that of buying the car and taking the new Job.
3) In the situation I've been explaining, this third choice might be your best option. You might be able to employ a buy-and-hold strategy that yields a greater overall return than your cost of interest on the loan. This is a win-win situation. Not only can you a) get a new car b) increase wealth with a higher paying job you can actually cover and exceed the cost of interest by having a portfolio which will allow you to do so in a reasonable amount of time.
Remember these are fairly simplified and glib explanations. Look up opportunity cost and net Present Value and you should get some fairly concise explanations.
