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Unformatted text preview: Chapter 15: Investment, Time and Capital Markets CHAPTER 15 INVESTMENT, TIME, AND CAPITAL MARKETS TEACHING NOTES The primary focus of this chapter is on how firms make capital investment decisions, though the chapter also includes some topical applications of the net present value criterion. The key sections to cover are 15.1, 15.2, and 15.4, which cover stocks and flows, present discounted value, and the net present value criterion respectively. You can then pick and choose between the remaining sections depending on your time constraint and interest in the subject. Each of the special topics is briefly described below. Students will find NPV to be one of the most powerful tools of the course. You will notice that this chapter does not derive the rate of time preference; instead, it introduces students to financial decision-making. Students should have no problem comprehending the trade-off between consumption today and consumption tomorrow, but they may still have problems with (1 + R ) as the price of today’s consumption. Emphasize the opportunity cost interpretation of this price. Human capital theory is a topic that bridges Chapters 14 and 15. Interesting issues for discussion include the relationship between wages and education and the return on education. If students understand present value, mastering the NPV criterion is easy. However, applying the NPV rule is more difficult. Section 15.3 extends the discussion of present and future values by exploring the connection between the value of a bond and perpetuities. If students understand the effective yield on a bond, you can introduce the internal rate of return, IRR , and then discuss why the net present value, NPV, is superior to the IRR criterion. For a comparison of IRR and NPV , see Brealey and Myers, Principles of Corporate Finance (McGraw-Hill, 1988). Section 15.5 discusses risk and the risk-free discount rate. You can motivate the discussion of risk by considering the probability of default by different classes of borrowers (this introduces the discussion of the credit market that will take place in Section 17.1). This section introduces students to the Capital Asset Pricing Model. To understand the CAPM model, students need to be familiar with Chapter 5, particularly Section 5.4, “The Demand for Risky Assets.” The biggest stumbling block is the definition of β . If students have an intuitive feel for β , they may use Equation (15.7) to calculate a firm’s discount rate....
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This note was uploaded on 06/06/2011 for the course ECON 302 taught by Professor Avrin-rad during the Spring '09 term at University of Illinois, Urbana Champaign.
- Spring '09