Question

1. Explain when firms might use present value analysis.

2. Explain why bailing out a failing firm can be harmful to the economy.

Answer 1

Ques 1 ) A firm undertakes present value(PV) analysis to decide whether an investment if beneficial or not. If different investments/projects are said to generate varied return at different future dates. To analyse all these investments and choose the most profitable one, companies can do a PV analysis. On calculating the present values of future returns, companies can compare various options.

Ques 2 ) Bailing out a company is done when a business is in bankruptcy and the government/investors provides it with capital injection to survive such bankruptcy.

Although a bankrupt company has a lot of adverse effects on the economy, but there are adverse effects of bailing such companies as well.

The much precious capital infusion by government is from the people’s money which has high opportunity costs attached to it. Moreover, the present condition of the companies is due to bad business policies, management, etc. So saving such firms will not correct such problems.

Further, these bailouts also reduce the money supply in market and thus a negative effect for borrowers in economy in general. In some cases, taxes might rise as well.