INFLATION,MAINTENANCE OF CAPITAL,AND THE IRR MODEL: AN APPRAISAL AND ALTERNATIVE

Capital budgeting under inflationary conditions presents some additional implementation problems when computing the internal rate of return. This paper reviews an earlier proposal made in this journal and concludes that it has some technical deficiencies. Further, it does not have the flexibility needed to be congruent with a wide variety of concepts of capital maintenance and asset evaluation. An algorithm is developed that will permit the user to make a variety of assumptions and then solve for the IRR that is consistent with those assumptions.     

EOQ FORMULA: IS IT VALID UNDER INFLATIONARY CONDITIONS?

The classical analysis of the economic order quantity (EOQ) problem ignores the effect of inflation. When a firm's cost factors are expected to rise at an annual rate of 10 percent or more, what adjustments in order quantities should the firm make to control its lot-size inventory (or cycle stock)? Using a model that includes both inflationary trends and time discounting, it is concluded that inflation brings no incentive either to increase or to decrease order quantities. In addition, order quantities can be computed using the classical EOQ formula under inflationary conditions, provided that the cost of capital invested in inventory is interpreted as an inflation-free cost. This interpretation implies that changes in the inflation rate should not affect the cost of capital that is utilized in the EOQ formula for determining order quantities.     

Some Comments on the Validity of EOQ Formula under Inflationary Conditions

In an earlier issue of Decision Sciences, Jesse, Mitra, and Cox [1] examined the impact of inflationary conditions on the economic order quantity (EOQ) formula. Specifically, the authors analyzed the effect of inflation on order quantity decisions by means of a model that takes into account both inflationary trends and time discounting (over an infinite time horizon). In their analysis, the authors utilized two models: Current-dollars model and Constant-dollars model. These models were derived, of course, by setting up a total cost equation in the usual manner then finding the optimum order quantity that minimizes the total cost. Jesse, Mitra, and Cox [1] found that EOQ is approximately the same under both conditions; with or without inflation. However, we disagree with the conclusion drawn by [2] and show that EOQ will be different under inflationary conditions, provided that the inflationary conditions are properly accounted for in the formulation of the total cost model.     

INVENTORY MANAGEMENT AND CAPITAL BUDGETING: A PEDAGOGICAL NOTE

This paper shows, through an alternative development of the lot size model, how the methods of capital budgeting can be logically applied to the determination of optimal inventory levels. There is no reason why inventory management needs be treated any differently than the management of fixed assets. The rule that the stock of fixed assets should be expanded until the marginal rate of return equals the marginal cost of capital results from maximizing the present value of profits as a function of the investment level. In a like manner, the “square root” formula from inventory theory results from maximizing the present value of profits as a function of the investment in inventory. In addition, formulating the inventory problem as a capital budgeting problem has advantages for incorporating deterioration, obsolescence, and other costs into the model in a more logical and less intuitive way.     

A modified internal rate of return model for capital rationing in project selection

The ability of a company to finance viable projects depends on the availability of funds, and this too is a function of time, interest rate and risk factors among others. Factors such as these would lead to limited fund availability, which would necessitate capital rationing. Linear/integer programming and profitability index are often used to tackle this problem for optimal solution. A third approach utilizing a modified internal rate of return (IRR) is proposed. To overcome the difficulty usually encountered in calculating IRR, a small program coded in BASIC is presented. Even though discounting the cash outflows beyond the initial year should have been ideal in the linear programming formulation, this paper casts doubts as to the validity of the solution derived from it, as different discount rates seem to produce very conflicting results from the same set of investment options. This is also applicable to profitability index. While efforts are being made to correct these lapses, the modified IRR model has been found useful in arriving at an optimum solution both for the single-period as well as for the multi-stage situation.     

TRUST,SOCIAL CAPITAL,AND ECONOMIC DEVELOPMENT

Many argue that elements of a society's norms, culture, or social capital are central to understanding its development. However, these notions have been difficult to capture in economic models. Here we explore a possible role for “trustworthiness” as corresponding to social capital. Individuals are trustworthy when they perform in accordance with promises, even if this does not maximise their payoffs. The usual focus on incentive structures in motivating behaviour plays no role here. Instead, we emphasise more deep‐seated modes of behaviour and consider trustworthy agents being socialised to act as they do. To model this socialisation, we borrow from a process of preference evolution pioneered by Bisin and Verdier (2001). The model developed endogenously accounts for social capital and explores its role in the process of economic development. It captures in a simple, formal way the interaction between social capital and the economy's productive processes. The results obtained caution against rapid reform and provide an explanation for why late‐developing countries may not easily be able to transplant the modes of production that have proved useful in the West. (JEL: O1, O3, O4, Z1)     

THE WELFARE GAINS OF FINANCIAL LIBERALIZATION: CAPITAL ACCUMULATION AND HETEROGENEITY

Research has shown that, absent individual heterogeneity and under complete markets, the welfare impact of financial openness is quantitatively limited. Not only are inequalities in wealth and labor productivity a feature of most societies, but also financial markets suffer from many well‐known frictions. This paper demonstrates that, when households face borrowing constraints and uninsurable idiosyncratic shocks to income, the welfare implications of financial liberalization are considerable. For instance, the average increase in welfare of a typical emerging market economy that switches from a closed capital market to perfect capital mobility is equivalent to a permanent increase in average consumption of roughly 5.4%. This is about 3.9 times more than the welfare gains of the same policy under a complete markets environment without any individual heterogeneity. We show that individual heterogeneity accounts for two thirds of this additional increase in the average welfare gain; market incompleteness accounts for the remaining third. In our calibration, the median household in capital‐scarce countries is in favor of international financial integration. However, if the pivotal voter is wealthy enough then such reform might not be implemented, since richer households have a vested interest in capital market closedness.     

Risk of Extreme Events Under Nonstationary Conditions

The concept of the return period is widely used in the analysis of the risk of extreme events and in engineering design. For example, a levee can be designed to protect against the 100-year flood, the flood which on average occurs once in 100 years. Use of the return period typically assumes that the probability of occurrence of an extreme event in the current or any future year is the same. However, there is evidence that potential climate change may affect the probabilities of some extreme events such as floods and droughts. In turn, this would affect the level of protection provided by the current infrastructure. For an engineering project, the risk of an extreme event in a future year could greatly exceed the average annual risk over the design life of the project. An equivalent definition of the return period under stationary conditions is the expected waiting time before failure. This paper examines how this definition can be adapted to nonstationary conditions. Designers of flood control projects should be aware that alternative definitions of the return period imply different risk under nonstationary conditions. The statistics of extremes and extreme value distributions are useful to examine extreme event risk. This paper uses a Gumbel Type I distribution to model the probability of failure under nonstationary conditions. The probability of an extreme event under nonstationary conditions depends on the rate of change of the parameters of the underlying distribution.     

基于CAPM的BOT项目“有限追索权”融资决策模型

为研究BOT项目有限追索权融资中贷款资金与股本资金在贷方和项目公司之间合理分配问题(即BOT最优融资结构),本文考虑项目公司和贷方根据CAPM方法进行投资决策,通过分析它们投资策略在利益上的冲突关系而建立一个BOT融资模型,并且用博弈论方法研究模型最优解的存在性及其性质。研究结果不仅为项目公司和贷方提供了对BOT项目融资决策的理论方法,而且为政府对BOT项目的管理提供了重要的理论工具。     

THE CLASSIC ECONOMIC PRODUCTION QUANTITY MODEL WITH SETUP COST AS A FUNCTION OF CAPITAL EXPENDITURE*

The formulation of the classic economic production quantity (EPQ) model is extended to include setup cost as a function of capital expense. Additional capital will buy reduced setup cost. Thus, the objective now is to balance holding, setup, and capital expenses. This new formulation is solved under conditions where setup cost varies exponentially and linearly as a function of capital expense. Decision rules are formulated to indicate under what conditions setup cost reduction reduces total cost. For the linear function, it is shown that once the decision to reduce setup cost is justified, the optimal choice is the minimum setup cost that is technologically feasible.     

A profitability model for tactical planning

Simple models reflecting changes in aggregate company behaviour in response to changes imposed by management decisions and/or factors outside the direct control of management provide useful tools for tactical planning purposes.One such model is discussed in this paper. The model enables management to assess explicitly and quantitatively the effect on the rate of return on capital employed of primary causes of change in any of the key variables affecting company performance, such as the unit price, the unit cost, the output level and the capital employed. Simple functional relationships are proposed between the major variables in the model, such as the level of output and the unit cost, the unit price and the volume of sales, the working capital requirements and the general level of the firm's activity, etc. and these are based on analytical considerations, empirical evidence and a series of assumptions. These relationships give rise to a set of parameters which are incorporated in the model and describe the operational (cost structure), financial (capital structure) and marketing (elasticity of demand) position of the company under study.Numerical results obtained from the model seem to suggest that the sensitivity of the rate of return to some of the parameters and underlying assumptions is relatively small, implying that the inter-dependence between some of the variables can be ignored, thus simplifying the problems associated with data collection and model evaluation.Both the model and the methodology of analysis employed are flexible enough to allow: (1) application of the model to alternative sets of functional relationships between variables and/or underlying assumptions; (2) further decomposition of the model to include additional variables depending on the particular objectives of the study; (3) modification of the model to explore the effects of management decisions or those of changes in external factors on productive unit and product profitability; and (4) analysis of models reflecting the effects of changes which are imposed on the system on measures of business performance other than the rate of return on capital employed.     

THE MYSTERY OF THE PRINTING PRESS: MONETARY POLICY AND SELF‐FULFILLING DEBT CRISES

We study the conditions under which unconventional (balance sheet) monetary policy can rule out self‐fulfilling sovereign default in a model with optimizing but discretionary fiscal and monetary policymakers. When purchasing sovereign debt, the central bank effectively swaps risky government paper for monetary liabilities only exposed to inflation risk, thus yielding a lower interest rate. As central bank purchases reduce the (ex ante) costs of debt, we characterize a critical threshold beyond which, absent fundamental fiscal stress, the government strictly prefers primary surplus adjustment to default. Because default may still occur for fundamental reasons, however, the central bank faces the risk of losses on sovereign debt holdings, which may generate inefficient inflation. We show that these losses do not necessarily undermine the credibility of a backstop, nor the monetary authorities' ability to pursue its inflation objectives. Backstops are credible if either the central bank enjoys fiscal backing or fiscal authorities are sufficiently averse to inflation. (JEL: E58, E63, H63)     

BOT项目的可控制风险研究

BOT是一种高收益与高风险并存的投资模式,在项目公司无法把握政治风险、商业风险和通货膨胀等不可控制风险的情况下,如何减小或避免可控制的资本结构风险、竣工风险和收入等风险就显得犹为重要。本文通过分析项目公司的参与约束和偿债约束,在定量的确定了项目公司资本结构要求的基础上,给出了避免可控制风险的相关条件。     

THE DEMAND FOR LIQUID ASSETS,CORPORATE SAVING,AND INTERNATIONAL CAPITAL FLOWS

The recent period of capital outflows from emerging economies has coincided with an increase in their corporate saving. In this paper, we model corporate saving as a demand for liquid assets by credit‐constrained firms in a dynamic open‐economy macroeconomic model. We find that the implications of this model are very different from standard models, because the demand for foreign bonds is a complement to domestic investment rather than a substitute. We show that this complementarity is at work when an emerging economy is on its convergence path or when it has a higher TFP growth rate. This framework is consistent with a number of stylized facts found in high‐growth, high‐investment emerging economies.     

THE DETERMINANTS OF HUMAN CAPITAL FORMATION DURING THE EARLY YEARS OF LIFE: THEORY,MEASUREMENT, AND POLICIES

In this paper, I discuss a research agenda on the study of human capital accumulation in the early years, with a particular focus on developing countries. I discuss several methodological issues, from the use of structural models, to the importance of measurement and the development of new measurement tools. I present a conceptual framework that can be used to frame the study of human capital accumulation and view the current challenges and gaps in knowledge within such an organizing structure. I provide an example of the use of such a framework to interpret the evidence on the impacts of an early years intervention based on randomized controlled trial.     

INVENTORY DECISIONS UNDER INFLATIONARY CONDITIONS

The standard approach to inventory policy ignores the effect of inflation. This paper investigates a model that includes both inflationary trends and time discounting. The paper compares this model with the standard EOQ model and the analysis for a one-time change, found in previous literature.     

THE CAPITAL MARKET VALUE OF A MULTIPERIOD INVESTMENT WITH THE OPTION OF PREMATURE ABANDONMENT

Conventional approaches to determining optimal abandonment of a project under uncertainty either assume risk-neutrality or impose a mean-variance criterion. Risk-neutrality is unrealistic while the mean-variance criterion precludes determination of the optimal strategy without consideration of covariances of returns among projects. Further, the use of variance of present value as a risk measure may result in the “optimality” of a time 0 strategy that involves maintaining a position at time t that will be “suboptimal” and would not be maintained. The use of the multiperiod capital asset pricing model (CAPM) as a decision criterion is consistent with contemporary theory of market behavior and remedies the deficiencies of the mean-variance approach noted above. Computationally, the optimal strategy for abandonment, when the commitment must be made at time 0 (a lease, say), can be determined with little difficulty beyond that of mean-variance models. When time of abandonment can remain unspecified, the value of the prospect that abandonment will occur at the optimal time can be determined, though the technique necessary is considerably more complicated. In both cases, the marginal costs of commitments that limit discretion over abandonment can be determined and attributed to those commitments.     

投资方案内部收益率的分析

本文严格地证明了投资方案的内部收益率(IRR)与借款利率的关系,全部资金与自有资金的内部收益率的关系,以及不同的借款偿还方式对自有奖金内部收益率的影响。     

AUTOCORRELATED CASH FLOWS AND THE SELECTION OF A PORTFOLIO OF CAPITAL ASSETS *

Capital budgeting models for analyzing real assets typically are based on a set of restrictive assumptions that influence financial managers' decisions and may prevent optimization of the firm's objectives. This research examines the common restrictive assumption that cash flows are intertemporally independent by first developing an economic state and simulation model based on a Markov process for including autocorrelated cash flows in the capital budgeting decision process and then demonstrating why managers should include autocorrelated cash flows in capital budgeting models by empirically testing the impact of assuming intertemporally independent cash flows on capital budgeting decisions. The results indicate that ignoring autocorrelated cash flows seriously limits the ability of capital budgeting models to provide optimal investment decisions. The model also is very attractive for practical application because it can be implemented with a minimum number of estimates and provides the set of input data required by a number of capital budgeting models. A discussion of the implementation of the model is included.     

A practical approach to risk and sensitivity analyses

The financial evaluation of capital investment projects is made using one or more of the conventional techniques such as payback period, accountant's rate of return, net present value and discounted cash flow rate of return. These techniques are generally used by firms to provide one ‘most likely’ estimate of the project's performance expressed in terms of its pay back period, rate of return or net present value. This approach fails to take into account the extent of the uncertainty or risk associated with the project. This paper presents the nature and scope of risk and sensitivity analyses. A case study on the application of risk and sensitivity techniques is also included.