15. investment and the employment of capital
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Transcript of 15. investment and the employment of capital
The Pricing of Capital andCapital Services
• Factor prices versus the price of factor services
– factor prices and factor rental rates
– stocks and flows
• Profit maximising employment of capital
– marginal cost of capital (MCK)
– marginal revenue product of capital (MRPK)
– profit maximising in perfect capital markets
The Pricing of Capital andCapital Services
• Factor prices versus the price of factor services– factor prices and factor rental rates
– stocks and flows
• Profit maximising employment of capital– marginal cost of capital (MCK)
– marginal revenue product of capital (MRPK)
– profit maximising in perfect capital markets
– profit maximising given monopsony power in capital markets
The Demand for and Supply ofCapital Services
• The demand for capital services– individual firm’s demand
– market demand
• The supply of capital services– supply to a single firm
– supply by a single firm• short-run MC
• long-run MC
– market supply
• The price of capital services
S
D
O
Re
Qe
Re
nta
l ra
te (
£)
Quantity per period
Long-run equilibrium rental rate in the market for capital services
Investment Appraisal
• Capital for purchase: investment
• Investment demand– calculating the benefits of investment
– discounting• present value approach
• rate of return approach
– the risks of investment
• The supply of capital– supply of physical capital
– supply of finance
Investment Appraisal
• Calculating the costs of capital– sources of investment finance
• retained profits
• borrowing from the banking sector
• share issue
– leverage and the cost of capital• leverage and the risks to suppliers
• measures of leverage– gearing ratio
– debt / equity ratio
The debt / equity ratio
O
Co
st o
f ca
pita
l (%
)
Ratio of debt to equity
Cost of equity
Cost of debt
O
Co
st o
f ca
pita
l (%
)
Ratio of debt to equity
Cost of equity
Cost of debt
Weighted average costof capital
The debt / equity ratio
Investment Appraisal
• Calculating the costs of capital– sources of investment finance• retained profits
• borrowing from the banking sector
• share issue
– leverage and the cost of capital• leverage and the risks to suppliers
• measures of leverage– gearing ratio
– debt / equity ratio
– risk premia
Financing Investment
• Sources of business finance
– internal sources
– external sources
• short-term finance
• medium-term finance
• long-term finance
– international sources
– comparison of the UK with other EU countries
Financing Investment
• The role of the financial sector– expert advice– expertise in channelling funds–maturity transformation– risk transformation
• Financial institutions in the UK– retail banks– investment banks (wholesale banks)• merchant banks• overseas banks
– finance houses
The Stock Market
• The role of the Stock Exchange– primary market– secondary market– advantages• brings together savers & firms seeking
investment• regulates firms & helps instil confidence• facilitates mergers and takeovers• reduces transaction costs of investment
finance
– disadvantages• cost of getting listed• possible short-termism and instability
The Stock Market
• Is the stock market efficient?– the efficient market hypothesis
– weak form of efficiency• where share dealing prevents cyclical
fluctuations in share prices
– semi-strong form of efficiency• where share prices adjust fully to publicly
available information
• chances, however, of 'insiders' gaining
– strong form of efficiency• where share prices adjust fully to all relevant
information (including 'inside information')