Investment decision rule

At this point chosen we can see that mrt is smaller

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Unformatted text preview: above. And suppose that you choose an investment level below the optimal level. Then compare the slope of the capital market line at that point ( ­(1+r)) and the slope of the investment opportunities curve (MRT). We can see that MRT is greater than –(1+r), which means that the present value of benefits exceeds the present value of cost (in this case, opportunity cost of capital: the interest rate you can get by choosing to save money rather than investing) from an additional one unit of investment. Therefore, we take this one unit of additional investment. Now suppose that you choose an investment level above the optimal level. At this point chosen, we can see that MRT is smaller than –(1+r), which means that the opportunity cost of capital is greater than MRT (investment return) for an additional one unit of investment at that point. In other words, you will lose money if you invest this one more unit at that point. In fact, at the optimal investment level, MRT is...
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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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