Finance. Lecture 04

Finance WISE 2023
INDEX
Economic principles of investments (I)......................................................................................... 2
Economic principles of investments (II) ....................................................................................... 2
Importance of the investment calculation ..................................................................................... 2
Main questions to be answered ..................................................................................................... 3
Dynamic investment methods ....................................................................................................... 3
Monetary concept of capital flows within the organizational context........................................... 4
Types of investments ..................................................................................................................... 4
Principle of causation .................................................................................................................... 5
Time Value of Money (TVM) .................................................................................................... 5-6
Hypothetical Yield Curve .............................................................................................................. 6
1
Finance WISE 2023
4.1 Economic principles of investments (I)

• Review: Companies have scarce resources and must therefore operate efficiently.
• Economic principle: Achieving the greatest possible outcome with the available
resources through efficient and effective resource allocation.
• In the context of the investment calculation:
− Achieve the greatest possible financial benefit for investors / shareholder /

owners (capital gain) with given financial means (financing) through goal
oriented use (investment).
4.2 Economic principles of investments (II)
4.3 Importance of the investment calculation

Business perspective:
 The companies must remain competitive (it’s important for customers (offer good
products), competitors (make progress), shareholders (stay in market), capital,
employees (attract good employees)).
 Economic point of view: Investment of high importance for economic growth,

international competitiveness; the prosperity of an economy.
 Investment calculation provides a framework for distinguishing between advantages

and non-profitable investment or selecting the investment with the highest advantage.
2
Finance WISE 2023
4.4. Main questions to be answered
Advantageousness: Is the realization of an investment object (IO) profitable?
Ranking order: Which of several investment objects brings the greatest advantage?
Marginal price: How high may the maximum purchase price be so that the investment object
is still advantageous?
4.5 Dynamic investment methods

• Dynamic methods use cash flows, that is, incoming and outgoing payments.
• The amount and time of the payment is important.
• Problem: Payments at different point in times are not directly comparable (see time
preference).
• Solution: All payments are related to a point in time by means of compounding or
discounting.
3
Finance WISE 2023
4.6 Monetary concept of capital flows within the organizational context
 Investment in the broader sence:

Use of capital = Use of money raised for business purposes
 Investment in the narrower sence:

significant disbursements for long-lasting assets
4.7 Types of investments
4
Finance WISE 2023
4.8 Principle of causation

According to the principle of causation, the investment calculation may only be based on those
payments and receipts which are directly caused by the investment objective (IO) or by the
disbursement of the investment.
I. Examples of IO of disbursements (cash outflows): out of the company
• Ongoing payments for interest, salaries, suppliers, materials, rent
• Demolition cost at the end of the useful life
• Acquisition payment
II. Examples of IO receipts (cash inflows):
• Proceeds form the sale of products
• Loan, equity
• Residual sales proceeds of the IO at the end of the useful life
4.9 Time Value of Money (TVM)

• Interaction of lenders with borrowers sets an equilibrium rate of interest i.
• Borrowing: return on loans exceeds cost of the borrowed funds.
• Lending is only worthwhile if the return is at least equal to that which can be obtain
from those alternative opportunities in the same risk class.
• In order to part with their money, investors require compensation for:
o Uncertainty of future payments
o The time resources are committed (the longer it takes higher interest)
o The expected rate inflation
• The real risk-free rate of interest is the exchange rate between future consumption and
present consumption.
I. Account for inflation…

• This rate of interest can be thought of as “pure” rental rate on money in the absence of
inflation and risk.
• Borrowers are willing to pay to be able to spend more than their current resources allow.
• Savers need compensation in order to give up the right to consume today.
• If the future payment will be diminished in value because of inflation, then investors
will demand an interest rate higher than the real risk-free interest rate so that their
expected purchasing power will actually increase.
• The nominal risk-free rate of interest adjusts the real risk-free rate to reflect expected
inflation over the life of the investment. (government)
5
Finance WISE 2023
• Taking into account these two factors (time and expected inflation) compensates
investors for the “time value of the money”.
II. Accounting for uncertainty…

• Investors tend to be risk-averse, meaning that they need sufficient expected additional
compensation in order to bear the additional risk.
• If the future payment from an investment is uncertain, investors will demand an interest
rate that exceeds the nominal risk-free rate of interest to provide a risk premium.
• The sum of the nominal risk-free interest rate and the risk premium on an investment
gives that investment’s required rate of return.
• For riskier investments, the risk premium, and therefore the required rate of return, will
be higher than for lower risk investments.
4.10 Hypothetical Yield Curve
 An upward sloping yield curve.

 Upward slope due to an increase in expected inflation and due to the increasing maturity
risk premium.

Finance. Lecture 04

Uploaded by

Copyright:

Available Formats

Finance. Lecture 04

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Finance. Lecture 04

Uploaded by

Copyright:

Available Formats

Finance WISE 2023

4.1 Economic principles of investments (I)

− Achieve the greatest possible financial benefit for investors / shareholder /

4.2 Economic principles of investments (II)

4.3 Importance of the investment calculation

 Economic point of view: Investment of high importance for economic growth,

 Investment calculation provides a framework for distinguishing between advantages

4.4. Main questions to be answered

Advantageousness: Is the realization of an investment object (IO) profitable?

4.5 Dynamic investment methods

4.6 Monetary concept of capital flows within the organizational context

 Investment in the broader sence:

 Investment in the narrower sence:

4.7 Types of investments

4.8 Principle of causation

4.9 Time Value of Money (TVM)

I. Account for inflation…

II. Accounting for uncertainty…

4.10 Hypothetical Yield Curve

 An upward sloping yield curve.

You might also like