Author Question: Explain what decisions and calculations a firm must make when it is considering the purchase of new ... (Read 71 times)

MGLQZ · **on:** Jun 30, 2018

Explain what decisions and calculations a firm must make when it is considering the purchase of new capital (i.e., making an investment decision).

What will be an ideal response?

Question 2

If the nominal interest rate 8 and expected inflation 3, the expected real interest rate in year t is approximately

A) 2.
B) 3.
C) 5.
D) 8.
E) 11.

kilada · **Reply #1 on:** Jun 30, 2018

Answer to Question 1

A firm must form expectations of future expected profits (per unit of capital). This implies that they must also form expectations of future output which are correlated with future profit. They must also form expectations of future interest rates to calculate present values. And finally, they must know the current price of the project and the rate of depreciation. Once they do all of this, they calculate the discounted present value of the project and compare that with its price.

Answer to Question 2

C