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 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,
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,
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,
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,
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, 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, 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)
16. In the United States, individual retirement accounts (IRAs) are called ________ rather than
________ because any amounts withdrawn from the plan are taxed at the time of withdrawal.
a) tax advantaged; tax deferred b) tax deferred; tax exempt
c) tax advantaged; tax loopholes d) tax exempt; tax deferred
Answer: (b)
17. The present value of one’s future labor income is called ________ and the constant level of
consumption spending that has a present value equal to one’s human capital is called ________.
a) human income; taxable income b) human capital; permanent income c) permanent capital; taxable income d) permanent income; human capital
Answer: (b)
18. The ________ the interest rate, the ________ the value of human capital, but the higher the
level of permanent income.
a) lower; lower b) higher; lower c) higher; higher d) lower; higher
Answer: (b)
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