Question

1. List the principal determinants of capital investment

2. Explain what is meant by the "marginal efficiency of capital." What is its role in determining the present value of an investment

3. Why is investment commonly a discrete, non-continuous function with respect to interest rates? Distinguish among the main ways by which firms finance investment.

4. Explain the accelerator principle.

Answer 1

1) Capital investment refers to a firm's aquisition of capital assets or fixed assets that are expected to be productive over many years.

Following are the principal determinants of capital investment

• Interest rate
• Availability of finance
• Risk
• Return
• State of technology
• Economic growth
• Confidence
• The rate of tax

2) Explain what is meant by" marginal efficiency of capital". What is its role in determining the present value of an investment?

Marginal efficiency of capital refers to expected profitability of an investment. It displays the expected rate of return on investment at a particular given time.

J.M. Keynes defines marginal efficiency of capital as the:

“The rate of discount which makes the present value of the prospective yield from the capital asset equal to its supply price”.

An investor while making a new investment, weighs the MEC of new investment against the prevailing rate of interest. As long as the MEC is higher than the rate of interest, the investment will be made till the MEC and the rate of interest are equalized.

3)Why is investment commonly, a descrete non continuous function with respect to interest rate?

Desrete function is a function that is defined only for a set of numbers that can be listed, such as the set of whole numbers or the set of integers.is investment commonly, a descrete non continuous function with respect to interest rate because interest rate is the major determinat of investment.

4)Distinguish among the main ways by which firms finance investment.

• RETAINED EARNINGS:

This is the most basic source of funds for any company and hopefully the method that brings in the most money, and is known as retained earnings.

• DEBT CAPITAL:

his can be done privately through bank loans, or it can be done publicly through a debt issue. These debt issues are known as corporate bonds, which allows a wide number of investors to become lenders (or creditors) to the company.

• EQUITY CAPITAL

A company can generate money by selling part of itself in the form of shares to investors, which is known as equity funding. The benefit of this is that investors do not require interest payments like bondholders do.

4. Explain the accelerator principle

acceleration principle is based on the fact that the demand for capital goods is dereived from the demand for consumer goods which are produced with the help of capital goods. If the demand for consumer goods increases the derived demand for the factors of production ,which goes to produce the goods will increase.The acceleration principle is an economic concept that draws a connection between changing consumption patterns and capital investment