chapter 11
For each of the following, decide whether you agree or disagree and explain your answers. Savings and investment are just two words for the same thing.
. Disagree: Savings is the supply of capital from households and investment is the demand for capital from firms.
Why might these options have been less attractive to Spark Therapeutics?
A+B ONLY a. Too little funding available. B. Too many strings attached or too costly.
On January 30, 2015 Spark Therapeutics, a gene therapy company based in Philadelphia that started operations in October 2013, offered 7 million shares of stock at an introductory price of $23 per share (an initial value of over $160 million) through an IPO on the NASDAQ stock exchange. At the end of the same day, Spark Therapeutics stock had closed at a price of $50.00 per share, 117 percent above its IPO price. Why might a company like Spark Therapeutics choose the IPO route to raise funds?
All of the above are plausible.
How can you measure the value of physical capital?
By estimating its current market value.
When I buy a share of Microsoft stock, I have invested; when I buy a government bond, I have not.
Disagree: Neither purchasing a share of stock nor buying a government bond is an investment.
Higher interest rates lead to more investment because those investments pay a higher return.
Disagree: When interest rates are LOW, the opportunity cost of an investment project is lower, and firms are MORE likely to invest in new plants and equipmeNT
The present discounted value of $1,000 to be received in three years will increase as the interest rate increases.
FALSE
the market interest rate falls, the present value of money one year from now will:
INCREASE
Abigail, an analyst with a venture capital firm, is approached by Tomas about financing his new business venture, a company that will produce solar-powered hydroponic growing equipment for light industrial use. What information should Abigail have before making a decision about financing Tomas's new company?
Information that would allow her to calculate an expected rate of return on the investment
Abigail, an analyst with a venture capital firm, is approached by Tomas about financing his new business venture, a company that will produce solar-powered hydroponic growing equipment for light industrial use. What information should Abigail have before making a decision about financing Tomas's new company?
Information that would allow her to calculate an expected rate of return on the investment
The Federal Reserve Board of Governors has the power to raise or lower short-term interest rates. Between 2005 and 2006, the Fed aggressively increased the benchmark federal funds interest rate from 2.5 percent in February 2005 to 5.25 percent in June 2006, where it remained until July 2007. From July 2007 to December 2008, the Fed rapidly decreased the federal funds rate, where it dropped to 0.16 percent and has remained between 0.07 percent and 0.20 percent through the middle of 2015. Assuming that other interest rates also increased and then decreased along with the federal funds rate, what effects do you think those moves had on investment spending in the economy?
Investment spending declined when interest rates were higher and then increased when interest rates fell.
The town council's finance committee has evaluated data and determined that the present discounted value of the benefits from a proposed dog park comes to $3.25 million. The total construction cost of the dog park is $2.7 million. This implies that the dog park should be built. Do you agree with this conclusion? Explain your answer.
It should be built at a cost of $2.7 million because its present value is greater than that amount.
What do you think the Fed's objective was in increasing, and then decreasing, the federal funds rate?
It increased the rates to keep inflation under control and decreased them later to boost economic growth.
Why is investment so important for an economy?
It is the flow of investment that increases the capital stock.
When and why might the Fed decide to start raising the federal funds rate?
It might increase the fed funds rate if and when it believes that inflation may become a problem for the economy.
In economics, the term investment means:
new capital additions to a firm's capital stock, measured over time.
A roll of 20 Kennedy half dollar coins
not a form
Cans of paint at Home Depot
not a form
40 shares of Apple stock
not a form of capital
An individual retirement account (IRA) at Wells Fargo Bank
not a form of capital
The Ben and Jerry's Waterbury, Vermont ice cream factory
physical capital
For a capital asset to depreciate, it must be ________.
physically worn out due to use
Channeling household savings into investment projects where the investment is paid for through internal funds from the investing firm is accomplished through the mechanism called
retained earnings
An all-terrain vehicle used by park rangers at Yellowstone National Park
social infracstructure
Capital is a stock measure and refers to those goods produced by the economic system that are used as inputs to produce other goods and services in the future.
stock
Wrigley Field, home of the Chicago Cubs
tangible physical
The Texas Giant roller coaster at Six Flags Over Texas
tangible capital
The expected rate of return on a project is best described as:
the annual rate of return that a firm expects to obtain through a capital investment.
The investment demand curve has this slope because firms will only invest in more capital as long as:
the rate of return on that investment exceeds the interest rate on loans available with comparable risk.
In modern industrial societies, investment decisions are made primarily by firms.
true
The benefits of any investment project take the form of future profits.
true
The interest rate determines the direct cost or the opportunity cost of each investment project.
true
The net income of a firm is called profits.
true
The Blume quintuplets, Aster, Dahlia, Iris, Jasmine, and Poppy, have an opportunity to purchase a wholesale florist company. Each of the women would have to put up $300,000 to make the purchase. The revenue from the business is expected to remain constant at $650,000 per year for the next several years. The costs (not including the opportunity costs of the investment) of operating the florist are expected to remain constant at $530,000 for the next several years. The current market interest rate on enterprises with comparable risks is 9.56 percent per year.
No, the expected rate of return is less than the market interest rate.
The Blume quintuplets, Aster, Dahlia, Iris, Jasmine, and Poppy, have an opportunity to purchase a wholesale florist company. Each of the women would have to put up $300,000 to make the purchase. The revenue from the business is expected to remain constant at $650,000 per year for the next several years. The costs (not including the opportunity costs of the investment) of operating the florist are expected to remain constant at $530,000 for the next several years. The current market interest rate on enterprises with comparable risks is 9.56 percent per year. Should the Blume quintuplets purchase the wholesale florist?
No, the expected rate of return is less than the market interest rate. Your answer is correct.
What are some of the other options that the company might have consideterm-47red before deciding on the IPO? (Check all that apply.)
Sell bonds. Use internally generated funds. Approach a venture capital fund.. Obtain bank loans.
correct,Text Problem 3.3 Question Help In March 2015, the Willis Tower in Chicago was sold to the Blackstone Group, a global investment firm, for $1.3 billion, the highest price ever paid for a U.S. office building outside of New York City. If you were a real estate investment company considering bidding on this building, what would you want to know? What specific factors would you need to form expectations about? (Check all that apply.)
Taxes and costs Demand for rental space Vacancy rates rent per square ft
The text states that in terms of value, the majority of stock in the United States is held by households through institutions and the percentage of institutional holding of stock (as well as the percentage of insider holding) often varies based on the maturity of the company. Think about publicly traded companies—those that are relatively new and the others that are relatively mature. Describe the variation in the percentage of shares held by institutions and the percentage of shares held by insiders for the two companies.
The MORE mature company will have a much LARGER percentage of shares held by institutions and a much smaller percentage of shares held by insiders than will the NEWER company.
On October 28, 2011, the St. Louis Cardinals won game 7 of the World Series. For the next month the stock market fell. The S&P 500 index (an index of the stock prices of the 500 largest corporations in the United States) dropped from 1,285.96 to 1161.41 on November 25. Ten-year Treasury notes were paying 2.31% on 10-year obligations of the government. The Fed had recently announced its intentions to keep its target for the federal funds rate between 0 and 0.25 percent for at least another year. What explanation can you give for this dramatic change in interest rates?
The economy was coming out of a severe recession in 2011, so the Fed maintained low interest rates to stimulate the economy.
Suppose a firm wants to borrow $10,000 for a capital investment project and faces an interest rate of 6 percent. What must be true of the rate of return on the project in order for the firm to undertake the venture?
The firm will borrow the money so long as the expected additional revenue is at least as large as the interest rate.
Lending institutions charge different interest rates for different classifications of mortgages. Two of these mortgage types are Alt-A mortgages and subprime mortgages. Alt-A mortgages generally carry a higher interest rate than a typical "prime rate" mortgage, and subprime mortgage rates are generally even higher than Alt-A rates. What is the likely economic justification for the higher interest rates for these two types of mortgages?
These are considered riskier loans because of the borrower's poor credit history or low credit score.
How do the saving decisions of households constrain the amount of investment that firms can undertake?
When households decide how much to save, it determines the amount of investment that firms can undertake.
The following list shows the expected rate of return for three investment projects: Project X: 14% Project Y: 9% Project Z: 4% If the interest rate is 7%, which investment project or projects will be funded?
X and Y
Assume that I promise to pay you $100 at the end of each of the next 3 years. Using the following formula, X=$100(1+r)+$100(1+r)2+$100(1+r)3, if r=0.075 (7.5%) , then X=$260.06. Assume that somebody of roughly comparable reliability offers to pay out 7.5 percent on anything you let him or her borrow from you. Would you be willing to pay me $254 for my promise? Explain your answer.
You would be willing to pay $254 for the promise, because its present value is greater than that amount.
What information would you need to form those expectations?
You would need to evaluate the expected flow of future productive services that the investment will yield.
Household savings can be directed toward investment in:
a and b venture capital stocks and bonds
Considering whether to undertake an investment project requires:
a and c an evaluation of the future productive services that an investment project will yield. comparing future benefits with the possible alternative uses of the funds required to undertake the project.
On January 30, 2015 Spark Therapeutics, a gene therapy company based in Philadelphia that started operations in October 2013, offered 7 million shares of stock at an introductory price of $23 per share (an initial value of over $160 million) through an IPO on the NASDAQ stock exchange. At the end of the same day, Spark Therapeutics stock had closed at a price of $50.00 per share, 117 percent above its IPO price. Why might a company like Spark Therapeutics choose the IPO route to raise funds?
all above It gave the company the best chance to raise a large amount of capital. B. Using an IPO would help increase public awareness of the company. C. Spark Therapeutics would have broader discretion over the use of funds generated through an IPO. D. Doing so would enable Spark Therapeutics to create a public market for its common stock.
Which of the following is an example of how savings can be channeled into productive investment?
all above Savings can be borrowed by firms, which can purchase new technology, engage in research to develop new technology, expand existing plants, or build new plants. B. Savings can be borrowed from banks or by a firm issuing bonds. C. Savings can be borrowed by individuals, who can invest in human capital (college education, professional school, or technical training) or purchase newly constructed houses.
Describe the capital stock of your college or university.
all above The education and training of its faculty. B. Its academic reputation. C. Its buildings, laboratories, desks, and chairs.
If an investment project costs $400,000 and saves $100,000 per year, the expected rate of return of the investment is 25 percent. Calculate the rate of return on a similar investment.
an investment project costs $400,000 and saves $100,000 per year, the expected rate of return of the investment is 25 percent. Calculate the rate of return on a similar investment. The rate of return on a $375,000 investment that saves $135,000 per year is 3636 percent. (Enter your response rounded to two decimal places.)
A contract between a borrower and a lender, in which the borrower agrees to pay the loan at some time in the future, is called a ▼ bond stock . This represents a loan made by households ▼ directly indirectly to the firm.
bond, directly
Institutions in which households supply their savings to firms that demand funds to buy capital goods are:
capital market
Investment by firms is the demand for capital, while savings by households is the supply of capital.
demand supply
An asset can be depreciated only if it wears out and is no longer functional.
false
An investment project will not be undertaken unless it is expected to yield less than the market interest rate.f
false
In economics, capital refers to money and financial assets such as stocks and bonds.
false
The primary risk of owning a mortgage is that the lender will default on the mortgage obligation.
false
Investment is a ________ measure and depreciation is a ________ measure.
flow flow
Which of the following are capital, and which are not? Lifeguard training and certification from the Red Cross
human capital
The Smithsonian National Air and Space Museum
infracstructure social
Nonmaterial things that contribute to the output of future goods and services best defines
intangible asset
The most common form of capital income received by households is
interest
Your Godmother left you an inheritance of $70,000, payable to you when you turn 26 years old. You are now 21. Currently, the annual rate of interest that can be obtained by buying 5-year bonds is 6.1 percent. Your mother offers you $57,268.23 cash right now to sign over your inheritance.
you should sign over your inheritance because the present value of $70,000 to be paid in 5 years is $52062.0352062.03. (Round your response to two decimal places.)
The present discounted value of $1,000 to be received in three years at an interest rate of 5 percent is
$863.84.
Households demand capital and firms supply capital. Do you agree or disagree?
Disagree: Households supply the funds, which are used by firms to purchase capital equipment.
Analyze the following statements and determine whether the statement is true or false. You may want to consult questions 5 and 6 from the Chapter 11 Appendix; however, these questions are not required to answer this problem. Ceteris paribus, the price of a bond increases when the interest rate increases.
False, because future bond payments will be discounted by more.
Ceteris paribus, the price of a bond increases when any given amount of money is received sooner rather than later.
True, because a given amount of money received sooner is discounted by less.
You and nine of your softball teammates are offered the chance to buy a pool hall. Each partner would put up $50,000. The revenues from the operation of the pool hall have been steady at $150,000 per year for several years and are projected to remain steady into the future. The costs (not including opportunity costs) of operating the pool hall (including maintenance and repair, depreciation, and salaries) have also been steady at $50,000 per year. Currently, 5-year Treasury bills are yielding 3.0 percent interest. Would you go in on the deal? Explain your answer.
Yes, the expected rate of return exceeds that of the opportunity cost of your money.
If the interest rate decreases, the likelihood that the dog park should be built will ____________.
increase, because future benefits will be discounted by less.
