THE THEORY OF INTEREST

the maximum present value to some other option, oralternative income stream, and that shift reacts on therate of interest.

In the example cited, if the rate of interest should be4% per cent instead of 5 per cent, the order of choicewould be changed. The present value of the land for A(farming) would be $10,000, for B (forestry), $9920, andfor C (mining), $9280. The farming use, or A, wouldnow be the best choice. Again, if the rate of interestshould be 4 per cent instead of 4% per cent, the presentvalue of the use of the land for A, farming purposes,would be $11,250; for B, forestry purposes, $11,300; andfor C, mining purposes, $9450. In this case, B, the forestryuse, would be chosen.

Thus, it would pay best to employ the land for miningif the rate of interest were 5 per cent, for farming if itwere 4y 2 per cent, and for forestry if it were 4 per cent.

The three options open to the owner of the land atthese three different rates of interest may be summarizedas follows:

Table 5

Present Values of the Three Options at Three Different Rates of

Interest

Options

Present Value at

5%

4y 2 %

4%

For forestry .

$8,820

9,000

9,110

$ 9,92010,0009,280

til,30011,2509,450

For farming .

Thus a change in the rate of interest results in a changein the relative attractiveness of different optional incomestream opportunities. A high rate of interest will en-courage investment in the quickly returning incomes,

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