Consists of expenditures on new plants,

capital equipment, machinery, inventories

and so on.
The investment decision is a :

Marginal benefit

expected rate of return

businesses hope to realize.

Marginal cost

interest rate

that must be paid for borrowed funds.

Basic determinants of investment spending:

1. Expected return (profit)

2. Rate of interest

Expected rate
of return = Profit / cost of machine

Cost of machine 1,000

Expected revenue from machine is 1,100
Nominal rate of interest VS. Real rate of interest

Nominal interest rate

Expressed in current dollar or peso.

Real interest rate

interest rate adjusted to inflation.

- Adjusted value
Example:

Expected rate of return is 10%, nominal interest rate is 15%

Ongoing in. Rate is 10%

Because the invesBng rm will payback dollar with

approximate 10 % less in purchasing power.
Given:
P5,000 cost of equipment
P5,500 net expected revenue
7% interest rate
14% nominal interest rate
8% ongoing in. rate

Compute the .:

1. Prot
2. Rate of return ( r)
3. interest cost
4. Real interest rate
5. Is it protable/unprotable? Why and
why not?
Given:
P100,000 cost of equipment
P120,000 net expected revenue
10 % interest rate
18 % nominal interest rate
9 % ongoing in. rate

Compute the .:

1. Prot
2. Rate of return ( r)
3. interest cost
4. Real interest rate
5. Is it protable/unprotable? Why and
why not?
 DEMAND CURVE

It shows the amount of investment

forthcoming at each real interest rate.

Real rate (i) and CumulaBve amount of

expected rate of return investment having this
(r) rate of return or higher
16 % $ 0
14 5
12 10
10 15
8 20
6 25
4 30
2 35
0 40
 16

14

12

10
Expected Rate of Return

IDC
8

5 10 15 20 25 30 35 40
Investment
 Shift of Investment Demand Curve

f retur n
Expected rate o

ID1

ID0
ID2

Investment
Shifts of the Investment Demand Curve:

1. Acquisition, maintenance and

operating costs

2. Business taxes

3. Technological change

4. Stock of capital goods on hand

5. Planned inventory changes

6. Expectations

7. Instability of investment
ACQUISITION , MAINTENANCE AND OPERATING COSTS

ID0

ID0
BUSINESS TAXES

ID1

ID2
TECHNOLOGICAL CHANGE

ID1

ID2
Stock of capital goods on hand

ID0

ID0
PLANNED INVENTORY CHANGES

ID1

ID2
EXPECTATIONS

ID1

ID2
INSTABILITY OF INVESTMENT

ID1

ID2
SEVERAL INTERRELATED FACTORS THAT
EXPLAIN THE VARIABILITY OF INVESTMENT

1.VARIABILITY OF
EXPECTATIONS

2. DURABILITY

3. IRREGULARITY OF
INNOVATION

4. VARIABILITY OF PROFITS

 Cost of machine = P5000

Expected gross revenue = P7,500

Operating costs = P 1,500

Interest rate = 12%

1. Determine the r

2. How much is the total profit?

3. How much will be added to the firms profit?

4. Does the investment makes sense? Why and

why not?
Cost of bldg. = 5M

Revenue after deducting its operating

cost = 5.5M

Nominal interest rate is = 12%

Ongoing inflation rate = 8%

What is the r?

How much is the firms profit?

Compute for the RIR

Does the investment profitable? Why and why

not?