Chapter Five
Household Savings and Investment Decisions
    This chapter contains 28 multiple choice questions, 10 short problems, and 9 longer problems.
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 p
lan. 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)
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.deductibleYou are currently renting a house for $12,000 per year and you also have an option to b
uy 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?

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