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EC 201 11-17-08 - Simplest all costs today all revenues in...

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EC 201 11-17-08 Present Discounted Value of $1 to be paid or in 1 year = ($1)/(1+i) PDV of $X to be paid or received in N years= $X/ (1+i) N How many years to double money? o If i=4%, ~18 years 6%, ~12 8%,~9 9%, ~8 Rule of 12 - Over usual range of interest rates, # of years to double money o 6% $100 today will grow to $200 in ~12 years o $1 in 12 years has PDV of ~50 cents if i=6% o Michigan Lottery jackpot $20 million – actually $1 million/year for 20 years <<$20 million Firm’s decision to undertake investment project o Criterion: invest if net present discounted value >0 o Net PDV= PDV(revenues)- PDV(costs)=PDV(R o -C o )+PDV(R 1 -C 1 )+PDV(R 2 -C 2 )+… o Now →not discounted =(R 0 -C 0 )+(R 1 -C 1 /1+i)+(R 2 -C 2 /(1+i) 2 )+(R 3 -C 3 /(1+i) 3 ) Typically, costs much earlier than revenues More likely to approve project if o 1. Finished sooner o 2. i lower because future revenues less discounted
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Unformatted text preview: Simplest: all costs today, all revenues in 1 yr. o Cost=$1000 today o Rev= $1100 in 1 yr. i Net PDV Action 5%-1000+(1100/1.05)=$47.12 Do it! 10%-1000+(1100/1.1)=0 do it 15%-1000+(1100/1.15)= -$43.48 Don’t do it!! o Firm’s D curve for loanable funds for investment • Supply of Loanable funds comes from saving done by households • Credit market equilibrium • In fact, family of i*, different i* depend on risk • Federal rate< safest companies< other companies< loan shark • Recent months: ↑↑ in risk premia, even for “solid” firms • “Usury Laws”= interest-rate ceilings • If usury ceiling> equil. Interest rate, equil. Legal →usury has no effect • But what if o 1. Law enforced and o 2. Usury ceiling < equil. ? • Shortage of credit is the difference between S s usury and I d usury •...
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EC 201 11-17-08 - Simplest all costs today all revenues in...

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