Suppose that you and I enter a contract and at some point in time you break the contract. Sidestepping if such terms were established before the contract was signed, what is the formula for determining the amount to be repaid?
I’m sure it should look something like this (i think)
Restitution = [(i*t*p) + p] – (tw*i*p)
P =principled borrowed
i = market interest rate
t= time borrowed
tw= time worked
Now, how do you calculate i(the market interest rate)? Would you use the opportunity cost of YOU’RE foregone investment, or simply an arbitrary opportunity cost? I ask only because the opportunity cost for myself and for, say, Warren Buffet is different given the same amount of money.
Read until you have something to write...Write until you have nothing to write...when you have nothing to write, read...read until you have something to write...Jeremiah
I'm not sure what kind of contract you are referring to, but it appears that you are refering to a labor contract in which the total cost of labor was paid for up front but ony a portion of the labor contracted for was completed. If this is the case, the issue could be addressed as follows.
First, we can address the interest that would be charged. The correct formula for interest, using your symbols, would be P(1+i)^t. However, time is usually represented by n, so the formula is P(1+i)^n. The penalties would have to be established by contract beforehand. There are several market interest rates at any given time, depending on the risk of the investment. It does not depend on the opportunity cost of the investor. In this case, I would argue that the interest rate should be appropriate for the risk of not having the work completed. This would be based on the percentage of similar contracts throughout the market in which work was not completed. The provider of the labor would not be entitled to any interest because they would have received their pay before the work started, so the formula would be (P-tw)[(1+i)^n].
"It does not depend on the opportunity cost of the investor. In this case, I would argue that the interest rate should be appropriate for the risk of not having the work completed. This would be based on the percentage of similar contracts throughout the market in which work was not completed. "
Solid point. I assume that the variations in oppertunity cost would be covered within the contract. So, Warren Buffets market fees for breaking a contract would be much greater than mine since my oppertunity costs is probably smaller then his.