Question

2. a) What do you mean by investment? Why are financial investments not considered as investment in Economics?
b) Briefly describe the determining factors of investment spending.
c) Cost for an investment project is Tk. 2000. Expected yields of the projects are Tk.1000 in the current year and Tk. 1150 in the next year. If the market interest rate is 10%, will it be amenable to undertake the project. How would your answer change if interest rate rises to 15%?

Answer 1

2.

A.

Investment refers to the activity or purchase of goods, instrument or device that is used to create wealth in the future. Goods owned under the investment is not considered for consumption in present time. Rather, it is used to facilitate income creation that builds wealth. For example, Buying a vehicle to use it to deliver goods to the customers, is considered as investment.

Financial investments are not considered as investments in Economics, because it is only a change of ownership and no any new goods is created. For example, buying stocks of one company means somebody sold it to me and to that seller, some other person or issuing company had sold. So, it is more of a trading where ownership is changing hands. Hence, it is not treated investment is Economics.

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B.

The first factor is the interest rate or expected return from the investment spending done. If actual return is higher than the minimum accepted return at the given interest rate. Then investment spending takes place. The second factor is economic development status. When economy is growing, then demand is being created, it causes investment spending to increase and vice versa. The third factor is investor confidence. A higher level of positive sentiments makes investment spending to increase and vice versa. The fourth factor is the technological advancements. It affects the productivity of capital and returns increases with increase in productivity. If it happens, then investment spending increases. If not, investment spending decreases.

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C.

When R = 10%

Then,

Net present value = -2000 + 1000 + 1150/1.1

Net present value = TK 45.45

Since Net present value, is positive, then project is good and can be accepted.

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When R = 15%

Then,

Net present value = -2000 + 1000 + 1150/1.15

Net present value = TK 0

Since Net present value, is 0, then there is no any gains on the given level of interest rate and economic profit will be zero. So, investors should be indifferent to the investment opportunity.