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Investment Considerations

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If you are an investor, why do you want to invest in the security market? Why do you want to invest in the stock market?

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Simply put, the investor is interested in maximizing their personal wealth. As such, they are following the primary rule of finance which is self interested behavior. This behavior dictates that any investor's primary goal is capital appreciation - capital gain over some period of time. Based upon the question above, we seem to be delineating between the securities market and the stock market. Essentially the securities market encompasses the stock market , so I am assuming you mean the debt market for securities, and the equity market for the stock market?

When we consider the debt market, we are usually interested in investing in Bonds, which are debt instruments which pay a stated amount of interest over a specific period of time (known as the maturity period). At the end of the maturity period the investor is entitled to their original investment amount being returned, and the interest payments are considered to be a return on their original investment. So the investor is creating an annuity, which is a fixed payment over a period of time, which usually results in moderate to lower level of return in terms of the risk taken. This approach involves the second principle of finance which relates to the time value of money. In this instance, the investor recognizes that money decreases in value over time (due to economic factors such as inflation, interest rates, reduction in purchasing power, and the like), but is willing to gain the return because it is relatively certain, consistent, and ...

Solution Summary

Investing in accord with the principles of finance - the factors involved and the potential impacts. A primer for developing an investment strategy.

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Considerations for Investments

139 #1, 5 (under questions sections), pg. 140 #2, 3 (under problems section)
1#. Comment on the following statements:
a. "Because our new expansion project has the same systematic risk as the firm as a whole, we need do no further risk analysis on the project."

b. "Our company should accept the new potash mine project at Moosejaw. The cost of additional loans to fund the project is 12 percent, and our simulations lead us to expect a 14 percent return from the project."
c. "It is difficult to decide whether to spend $10 million to reopen our mine because the price of gold is so uncertain. However, if we assume the price of gold grows at an average of 5 percent a year with a standard deviation of 20 percent a year, simulation indicates the mine has an average NPV of $500,000. Therefore, we should reopen."
5# what is the advantage of using certainty-equivalent cash flows instead of risk-adjusted discount rates to calculate the NPV of an investment project?

#2 In early 1990, Boeing Co. decided to gamble $4 billion to build a new long-distance, 350-seat wide-body airplane called the Boeing 777. The price tag for the 777, scheduled for delivery beginning in 1995, is about $120 million apiece. Assume that Boeing's $4 billion investment is made at the rate of $800 million a year for the years 1990 through 1994 and that the present value of the tax write-off associated with these costs is $750 million. Based on estimated annual fixed costs of $100 million, variable production costs of $90 million apiece, a marginal corporate tax rate of 34 percent and a discount rate of 14 percent, what is the break-even quantity of annual unit sales over the Boeing 777's projected 15-year life? Assume that all cash inflows and outflows occur at the end of the year.

3# The recently opened Grand Hyatt Wailea Resort and Spa on Maui cost $600 million, about $800,000 per room, to build. Daily operating expenses average $135 a room if occupied and $80 a room if unoccupied (much of the labor cost of running a hotel is fixed). At an average room rate of $500 a night, a marginal tax rate of 40 percent, and a cost of capital of 11 percent, what year-round occupancy rate do the Japanese investors who financed the Grand Hyatt Wailea require to break even in economic terms on their investment over its estimated 40-year life? What is the likelihood that this investment will have a positive NPV? Assume that the $450 million expense of building the hotel can be written off straight line over a 30-year period (the other $150 million is for the land which is not depreciable) and that the present value of the hotel's terminal value will be $200 million.

Compare the assumptions underlying Arbitrage Pricing Theory with those underlying the mean-variance Capital Asset Pricing Model. Which set of assumptions seems more realistic to you? Why?

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