Answer to Question #238014 in Financial Math for EmmahM

Question

James loves buying antique and sells it out someday. He loves so because he believes that it will give him more wealth. But James wants to maximize his profit by any mean. Given an antique that costs $2,000,000, and it inflates 6%, the bank rate is 12%, loan period is 20 years, payments and rates are considered annually. James has two plans: i. He borrows $2,000,000 to buy the antique. ii. Instead of buying the antique, James would use the annual payment to do investment in the stock market. Suppose it gives 12% annual return. Which plan will James choose if he wants to maximize his wealth after 20 years? 

Answer 1

Option 2 is should be chosen to maximise the wealth

Explanation:

In option 1, it can be clearly seen that buying antique by borrowing money, will erode the wealth, because antique will grow at 6% p.a. only while bank interest rate is 12% p.a. hence this option would decrease the wealth of james by $\frac{1.06}{1.12} - 1 = -5.36$

 

Option 2, this is the only option which can maximise the wealth, the value of investment in 20 years will be $= 2,000,000 \times 1.12^{20} = 19,292,586.19,$ hence option 2 is correct.