Time Value Of Money Assumptions

Which of the following is a violation of our assumptions about the time value of money?

(a) Noting that $10,000 in sales after taking into account $1,000 in expenses is a very good day for a hot dog stand.

Assumption: Benefits and costs are equal and opposite. Appreciating that the benefit of $9,000 in profit compared with the cost of $1,000 in expenses does indeed constitute a very good day is consistent with this assumption.

A violation of this assumption would be to dwell on the fact that, gee, $1,000 is a lot of money to put into hot dogs.

(b) Sticking with your decision you made a week ago not to go to the Cheerful Tortoise and study instead.

Assumption: People use exponential discounting in their decisionmaking. If you recognize that postponing the Cheerful Tortoise until after the midterm next week, when you will get to enjoy good grades and beer and onion rings is more valuable to you than going out tonight, you have created an exponential discounting rate. Sticking with this one week later is consistent with the assumption.

A violation of the assumption would be to switch to hyperbolic discounting, in which, the longer you put off getting the bigger future reward, the faster the incremental benefits of immediate gratification begin to grow relative to the incremental benefits of waiting for the big prize at the end. Under hyperbolic discounting, at some point before you reach the big payoff day, your value of immediate gratification will exceed that of waiting and you will opt for the smaller prize, ie the beer but not the good grades.

(c) Not taking three hours off work to fight a $30 parking ticket.

Assumption: Monetary benefits and costs are equal and opposite. Since you will probably make at least $30 by staying at work, staying is the consistent behavior.

Deciding that the satisfaction you would get from righting the injustice of the unfair ticket would more than make up for lost wages would be a violation of this assumption.

(d) None of the above.

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