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© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
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Ch10

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Transcript of "Ch10"

  1. 1. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair CHAPTERCHAPTER 1010 Prepared by: Fernando QuijanoPrepared by: Fernando Quijano and Yvonn Quijanoand Yvonn Quijano Input Demand:Input Demand: The Capital Market and theThe Capital Market and the Investment DecisionInvestment Decision
  2. 2. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair The Capital MarketThe Capital Market
  3. 3. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair CapitalCapital • One of the most important concepts in allOne of the most important concepts in all of economics is the concept ofof economics is the concept of capitalcapital.. • Capital goodsCapital goods are those goods producedare those goods produced by the economic system that are used asby the economic system that are used as inputs to produce other goods andinputs to produce other goods and services in the future.services in the future.
  4. 4. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Physical CapitalPhysical Capital • PhysicalPhysical, or, or tangibletangible,, capitalcapital refers to therefers to the material things used as inputs in thematerial things used as inputs in the production of future goods and services.production of future goods and services. • Major categories of physical capital:Major categories of physical capital: • Nonresidential structuresNonresidential structures • Durable equipmentDurable equipment • Residential structuresResidential structures • InventoriesInventories
  5. 5. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Social CapitalSocial Capital • Social capitalSocial capital is capital that providesis capital that provides services to the public.services to the public. • Major categories of social capital:Major categories of social capital: • Public works (roads and bridges)Public works (roads and bridges) • Public services (police and fire protection)Public services (police and fire protection)
  6. 6. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Intangible CapitalIntangible Capital • Nonmaterial things that contribute to theNonmaterial things that contribute to the output of future goods and services areoutput of future goods and services are known asknown as intangible capitalintangible capital.. • For example, an advertising campaign toFor example, an advertising campaign to establish a brand name producesestablish a brand name produces intangible capital called goodwill.intangible capital called goodwill.
  7. 7. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Human CapitalHuman Capital • Human capitalHuman capital is a form of intangibleis a form of intangible capital that includes the skills and othercapital that includes the skills and other knowledge that workers have or acquireknowledge that workers have or acquire through education and training.through education and training. • Human capital yields valuable services to aHuman capital yields valuable services to a firm over time.firm over time.
  8. 8. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Measuring CapitalMeasuring Capital • The measure of a firm’sThe measure of a firm’s capital stockcapital stock isis the current market value of its plant,the current market value of its plant, equipment, inventories, and intangibleequipment, inventories, and intangible assets.assets. • When we speak of capital, we refer not toWhen we speak of capital, we refer not to money or financial assets such as bondsmoney or financial assets such as bonds or stocks, but to the firm’s physical plant,or stocks, but to the firm’s physical plant, equipment, inventory, and intangibleequipment, inventory, and intangible assets.assets.
  9. 9. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair InvestmentInvestment • InvestmentInvestment refers to new capital additionsrefers to new capital additions to a firm’s capital stock.to a firm’s capital stock. • Although capital is measured at a givenAlthough capital is measured at a given point in time (a stock), investment ispoint in time (a stock), investment is measured over a period of time (a flow).measured over a period of time (a flow). • The flow of investment increases theThe flow of investment increases the capital stock.capital stock.
  10. 10. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Private Investment in the U.S.Private Investment in the U.S. Economy, 1999Economy, 1999 Private Investment in the U.S. Economy, 1999Private Investment in the U.S. Economy, 1999 BILLIONS OFBILLIONS OF CURRENTCURRENT DOLLARSDOLLARS AS A PERCENTAGEAS A PERCENTAGE OF TOTAL GROSSOF TOTAL GROSS INVESTMENTINVESTMENT AS AAS A PERCENTAGEPERCENTAGE OF GDPOF GDP Nonresidential structuresNonresidential structures 285.6285.6 17.317.3 3.13.1 Equipment and softwareEquipment and software 917.4917.4 55.655.6 9.99.9 Change in inventoriesChange in inventories 43.343.3 2.62.6 0.50.5 Residential structuresResidential structures 403.8403.8 24.524.5 4.34.3 Total gross private investmentTotal gross private investment 1,650.11,650.1 100.0100.0 17.817.8 −− depreciationdepreciation −− 961.4961.4 −− 58.358.3 −− 10.310.3 Net investment =Net investment = 688.7688.7 41.741.7 7.57.5 gross investment minus depreciationgross investment minus depreciation • DepreciationDepreciation is a decline in an asset’s economic valueis a decline in an asset’s economic value over time.over time.
  11. 11. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair The Capital MarketThe Capital Market • TheThe capital marketcapital market is ais a market in whichmarket in which households supply theirhouseholds supply their savings to firms thatsavings to firms that demand funds to buydemand funds to buy capital goods.capital goods.
  12. 12. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair $1,000 in Savings Becomes $1,000 of Investment$1,000 in Savings Becomes $1,000 of Investment
  13. 13. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Bond LendingBond Lending • AA bondbond is a contract between a borroweris a contract between a borrower and a lender, in which the borrower agreesand a lender, in which the borrower agrees to pay the loan at some time in the future,to pay the loan at some time in the future, along with interest payments along thealong with interest payments along the way.way. • In essence, households supply the capitalIn essence, households supply the capital demanded by a business firm.demanded by a business firm. Presumably, the investment will generatePresumably, the investment will generate added revenues that will facilitate theadded revenues that will facilitate the payment of interest to the household.payment of interest to the household.
  14. 14. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair The Financial Capital MarketThe Financial Capital Market • TheThe financial capital marketfinancial capital market is the part ofis the part of the capital market in which savers andthe capital market in which savers and investors interact through intermediaries.investors interact through intermediaries. • Capital incomeCapital income is income earned onis income earned on savings that have been put to use throughsavings that have been put to use through financial capital markets.financial capital markets.
  15. 15. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Capital Income: Interest and ProfitCapital Income: Interest and Profit • InterestInterest is the payment made for theis the payment made for the use of money. Interest is a reward foruse of money. Interest is a reward for postponing consumption.postponing consumption. • ProfitProfit is the excess of revenues overis the excess of revenues over cost in a given period. Profit is a rewardcost in a given period. Profit is a reward for innovation and risk taking.for innovation and risk taking.
  16. 16. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Financial Capital Markets in ActionFinancial Capital Markets in Action • Four mechanisms for channelingFour mechanisms for channeling household savings into investmenthousehold savings into investment projects include:projects include: • Business loansBusiness loans • Venture capitalVenture capital • Retained earningsRetained earnings • The stock marketThe stock market
  17. 17. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Financial Markets Link HouseholdFinancial Markets Link Household Saving and Investment by FirmsSaving and Investment by Firms
  18. 18. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Capital Accumulation and AllocationCapital Accumulation and Allocation • In modern industrial societies, investmentIn modern industrial societies, investment decisions (capital production decisions)decisions (capital production decisions) are made primarily by firms.are made primarily by firms. • Households decide how much to save, andHouseholds decide how much to save, and in the long-run saving limits or constrainsin the long-run saving limits or constrains the amount of investment that firms canthe amount of investment that firms can undertake.undertake. • The capital market exists to direct savingsThe capital market exists to direct savings into profitable investment projects.into profitable investment projects.
  19. 19. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Forming ExpectationsForming Expectations • Decision makers must haveDecision makers must have expectationsexpectations about what is going to happen in theabout what is going to happen in the future.future. • The investment process requires that theThe investment process requires that the potential investor evaluate the expectedpotential investor evaluate the expected flow of future productive services that anflow of future productive services that an investment project will yield.investment project will yield.
  20. 20. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair The Demand for New Capital and theThe Demand for New Capital and the Investment DecisionInvestment Decision • The ability to lend at the market rate of interestThe ability to lend at the market rate of interest means that there is anmeans that there is an opportunity costopportunity cost associated with every investment project.associated with every investment project. • The evaluation process thus involves not onlyThe evaluation process thus involves not only estimatingestimating future benefitsfuture benefits, but also comparing the, but also comparing the possiblepossible alternative usesalternative uses of the funds required toof the funds required to undertake the project.undertake the project. • At a minimum, those funds earn interest inAt a minimum, those funds earn interest in financial markets.financial markets.
  21. 21. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Comparing Costs and Expected ReturnComparing Costs and Expected Return • TheThe expected rate of returnexpected rate of return isis the annual rate of return that athe annual rate of return that a firm expects to obtain throughfirm expects to obtain through a capital investment.a capital investment.
  22. 22. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Determinants of theDeterminants of the Expected Rate of ReturnExpected Rate of Return • The expected rate of return on anThe expected rate of return on an investment project depends on:investment project depends on: • the price of the investment,the price of the investment, • the expected length of time the projectthe expected length of time the project provides additional cost savings or revenue,provides additional cost savings or revenue, andand • the expected amount of revenue attributablethe expected amount of revenue attributable each year to the project.each year to the project.
  23. 23. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair A Menu of Investment Choices andA Menu of Investment Choices and Expected Rates of ReturnExpected Rates of Return Potential Investment Projects and Expected Rates of Return for a Hypothetical Firm,Potential Investment Projects and Expected Rates of Return for a Hypothetical Firm, Based on Forecasts of Future Profits Attributable to the InvestmentBased on Forecasts of Future Profits Attributable to the Investment PROJECTPROJECT (1)(1) TOTALTOTAL INVESTMENTINVESTMENT (DOLLARS)(DOLLARS) (2)(2) EXPECTED RATEEXPECTED RATE OF RETURNOF RETURN (PERCENT)(PERCENT) A. New computer networkA. New computer network 400,000400,000 2525 B. New branch plantB. New branch plant 2,600,0002,600,000 2020 C. Sales office in another stateC. Sales office in another state 1,500,0001,500,000 1515 D. New automated billing systemD. New automated billing system 100,000100,000 1212 E. Ten new delivery trucksE. Ten new delivery trucks 400,000400,000 1010 F. Advertising campaignF. Advertising campaign 1,000,0001,000,000 77 G. Employee cafeteriaG. Employee cafeteria 100,000100,000 55
  24. 24. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair A Menu of Investment Choices andA Menu of Investment Choices and Expected Rates of ReturnExpected Rates of Return • When the interest rate isWhen the interest rate is low, firms are more likely tolow, firms are more likely to invest in new plant andinvest in new plant and equipment than when theequipment than when the interest rate is high.interest rate is high. • The interest rate determinesThe interest rate determines the opportunity costthe opportunity cost (alternative investment) of(alternative investment) of each project.each project.
  25. 25. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Investment DemandInvestment Demand • The market demand curveThe market demand curve for new capital is the sumfor new capital is the sum of all the individual demandof all the individual demand curves for new capital incurves for new capital in the economy.the economy. • In a sense, the investmentIn a sense, the investment demand schedule is ademand schedule is a ranking of all theranking of all the investment opportunities ininvestment opportunities in the economy in order ofthe economy in order of expected yield.expected yield.
  26. 26. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair The Profit-MaximizingThe Profit-Maximizing Investment DecisionInvestment Decision • A perfectly competitive profit-maximizingA perfectly competitive profit-maximizing firm will keep investing in new capital up tofirm will keep investing in new capital up to the point at which the expected rate ofthe point at which the expected rate of return is equal to the interest rate.return is equal to the interest rate. • This is analogous to saying that the firmThis is analogous to saying that the firm will continue investing up to the point atwill continue investing up to the point at which the marginal revenue product ofwhich the marginal revenue product of capital is equal to the price of capital.capital is equal to the price of capital. MRPK = PK
  27. 27. © 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair Present ValuePresent Value • The present value (The present value (PVPV), or present), or present discounted value, ofdiscounted value, of RR dollarsdollars tt years fromyears from now is:now is: • Lower interest rates result in higherLower interest rates result in higher present values. The firm has topresent values. The firm has to pay morepay more nownow to purchase the same number ofto purchase the same number of future dollars.future dollars.
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