Investment decision rule

Investment decision rule

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Unformatted text preview: words, invest up to the point where the slope of investment opportunities curve (this is called marginal rate of transformation, MRT) is equal to the slope of capital market line (which is –(1+r)). In this way, the firm can make sure that investors have the maximum amount of wealth, meaning that the capital market line is furthest away from the origin. 9. Investors now with the wealth generated by investment can transfer wealth (consumption) through time using capital markets. 10. In fact, choosing this optimal investment level (the point where MRT= ­(1+r)) is equivalent to an investment strategy where the firm takes all positive net present value (NPV) project. Also at the optimal level of investment, the total NPV is maximized. (That NPV is positive means that the present value of benefits exceeds the present value of costs.) 11. Let’s prove this equivalence. Suppose we found the optimal level of investment as I described...
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This note was uploaded on 03/19/2013 for the course FINA 2010 taught by Professor Jessica during the Spring '13 term at HKU.

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