Buying versus renting – Determinants of the net present value of home ownership for individual households

The tenure decision upon whether to buy or to rent accommodation has long-term consequences for households' financial wellbeing that influence macroeconomic development and stability when the cumulative effects of individual decisions are aggregated across populations. The author explains how the net present value (NPV) of ownership versus renting can be used as a framework for informing housing tenure decisions. Increases in holding periods, inflation and the spread between imputed rent and the opportunity cost of household savings shifts the balance in favour of ownership. With plausible assumptions the model demonstrates that households typically need a holding period of between five and ten years to achieve a breakeven NPV. The findings support the conjecture that inflation transfers wealth from renters and mortgage providers to owners, whereas deflation reverses the flow until rising default levels establish a new equilibrium.     

Managing for Value 2.0

In Finance 101, future corporate managers are taught that the social mission of public companies is to maximize their own longrun (or “intrinsic”) value by investing in all positive net present value (NPV) projects—that is, projects that are expected to earn at least their opportunity cost of capital. In markets that are reasonably efficient, provided management does an effective job of communicating its business plan and its progress in meeting its strategic goals, companies that follow this “NPV rule” can expect to be rewarded with increases in their share prices, at least in the longer run. But in the real world, of course, the pursuit of earnings and other “key performance indicators” (KPIs) often leads to managerial shortsightedness and destruction of value. To explain why—and to help companies avoid this outcome—this article presents an approach that envisions the intrinsic value of the company as an invisible “blue line” that moves through time on a graph, while showing observable key performance indicators, including revenue and earnings (and even the current stock price), as “red lines” on the same graph. The root of the problem is the failure of many companies to distinguish between their KPIs and the underlying drivers of value. KPIs, to be sure, are reflections of important aspects of the business; but however important and useful for strategic planning, they should not be used in performance evaluation or compensation plans for top management as surrogates for the underlying value of the business. Genuine value creation requires systems and a corporate culture that compel managers to pursue all projects that promise to earn the opportunity cost of capital—while treating earnings and other KPIs as means to creating value rather than ends in themselves.     

On the interest-rate elasticity of the demand for international reserves: Some evidence from developing countries

Contrary to what is suggested by the theory, most empirical studies on the demand for international reserves have failed to find a significant (negative) coefficient for the opportunity cost of holding reserves. In this paper it is argued that the reason for this is that the opportunity cost of holding international reserves has been measured incorrectly. In the empirical analysis presented in this paper the spread between the interest rate at which countries can borrow from abroad and LIBOR is used as a proxy for the net opportunity cost for holding reserves. The results obtained using data for a group of developing countries for 1976–1980 show that when this net opportunity cost is used, the regression coefficient is significantly negative.     

The non-neutrality of debt in investment timing: a new NPV rule

Summary Limited liability debt financing of irreversible investments can affect investment timing through an entrepreneur’s option value, even after compensating a lender for expected default losses. This non-neutrality of debt arises from an entrepreneur’s unique investment opportunity, and it is shown in a standard model of irreversible investment that includes the equilibrium effect of a competitive lending sector. The analysis is partial, in that it takes as exogenously given an entrepreneur’s use of debt. Intuitively, limited liability lowers downside risk for the entrepreneur by truncating the lower tail of risks, and lowers the investment threshold. Compensating the lender for expected default losses reduces project profitability to the entrepreneur, and increases the investment threshold. The net effect is negative, because lower downside risk has an additional impact on the option value of delaying investment. The standard NPV rule in real options theory implicitly assumes debt to be neutral. With non-neutrality of debt, an investment threshold is higher than investment cost, but lower than the standard NPV rule. Comparisons with other standard investment thresholds show similar relationships.     

Post-Tax Capital Investment Appraisal: Plant and Machinery

Tax considerations are important for companies which are no longer tax exhausted. Taxation has a major impact upon project yield and net present value (NPV) for capital investment in plant and machinery. This paper uses the weighted average cost of capital model to demonstrate that the impact of corporate taxation upon NPV need not be in the same direction as the impact upon yield. The NPV is reduced by the nominal 35% rate of corporation tax only when the pre-tax yield is very high; for low yielding projects the post-tax NPV can range from less than zero per cent to over 100% of the pre-tax NPV depending upon the gearing. The tax deductibility of the costs of the debt finance component of capital expenditure has a major and subtle interaction with other parameters which always favours high gearing.     

Optimal Financial Structure, Cost of Capital, and the Lease-or-Buy Decision

This note comments on the doubtful application of an economic concept of personal income to the non-personal business enterprise situation.
This paper presents a series of models which we believe properly reflect the relevant relationships in the lease or buy evaluation. The models present the proper cash flow variables for such an analysis and they present the impact on asset net present value of cost of capital and market risk assessment. Finally, the models reflect the simultaneous effect on asset and financial structure of the acceptance of a particular investment opportunity.     

SIMPLE RESOURCE ALLOCATION RULES: A NOTE ON A GENERALISATION

A stream of literature exists on the ability to pick payback hurdles such that use of the payback method replicates decisions based on net present value (NPV) analysis under circumstances where the basic shape of the cash inflow pattern associated with the investment opportunity facing the firm is assumed known. The literature has derived such payback hurdles for specific cash inflow pattern shapes (e.g., level, exponentially increasing/decreasing, arithmetic growth, etc.) The main concern of this note is to identify an expression for a general class of cash inflow pattern shapes (of which the specific shapes in the previous literature are examples) from which can be derived the payback hurdle corresponding to any specific shape belonging to the general class.     

A neural‐network‐based decision‐making model in the peer‐to‐peer lending market

This study proposes an investment recommendation model for peer‐to‐peer (P2P) lending. P2P lenders usually are inexpert, so helping them to make the best decision for their investments is vital. In this study, while we aim to compare the performance of different artificial neural network (ANN) models, we evaluate loans from two perspectives: risk and return. The net present value (NPV) is considered as the return variable. To the best of our knowledge, NPV has been used in few studies in the P2P lending context. Considering the advantages of using NPV, we aim to improve decision‐making models in this market by the use of NPV and the integration of supervised learning and optimization algorithms that can be considered as one of our contributions. In order to predict NPV, three ANN models are compared concerning mean square error, mean absolute error, and root‐mean‐square error to find the optimal ANN model. Furthermore, for the risk evaluation, the probability of default of loans is computed using logistic regression. Investors in the P2P lending market can share their assets between different loans, so the procedure of P2P investment is similar to portfolio optimization. In this context, we minimize the risk of a portfolio for a minimum acceptable level of return. To analyse the effectiveness of our proposed model, we compare our decision‐making algorithm with the output of a traditional model. The experimental results on a real‐world data set show that our model leads to a better investment concerning both risk and return.     

Investment decisions,net present value and bounded rationality

The Net Present Value maximizing model has a respectable ancestry and is considered by most scholars to be a theoretically sound decision model. In real-life applications, decision makers use the NPV rule, but apply a subjectively determined hurdle rate, as opposed to the ‘correct’ opportunity cost of capital. According to a heuristics-and-biases-program approach, this implies that the hurdle-rate rule is a biased heuristic. This work shows that the hurdle-rate rule may be interpreted as a fruitful strategy of bounded rationality, where several domain-specific and project-specific elements are integrated and condensed into an aspiration level. The paper also addresses the issue of a productive cooperation between bounded and unbounded rationality.     

Earnings Quality Based on Corporate Investment Decisions

In this paper, I examine a new approach for measuring earnings quality, defined as the closeness of reported earnings to “permanent earnings,” based on firm decisions with regard to capital and labor investments. Specifically, I measure earnings quality as the contemporaneous association between changes in the levels of capital and labor investment and the change in reported earnings. This approach follows the reasoning that (1) firms make investment decisions based on the net present value (NPV) of investment projects and (2) reported earnings with higher quality should more closely associate with real investment decisions. I find that measures of earnings quality based on managerial labor and capital decisions correlate positively with earnings persistence and have incremental explanatory power relative to earnings‐quality measures used in the accounting literature. Furthermore, investment‐based earnings‐quality measures are less informative when managers tend to overinvest.     

Disclosure Interactions and the Cost of Equity Capital: Evidence From the Spanish Continuous Market

Abstract:  The purpose of this paper is to provide some new evidence on the relationship between disclosure and the cost of equity capital. We propose a new specification for the empirical test based on the idea that in the previous models one crucial variable was missing: accounting policy choice. We test our theoretical hypothesis using a sample of Spanish firms quoted on the Spanish continuous market from 1999 to 2002. We adopt the ex-ante approach to measure the cost of equity capital, taking analysts predictions as a proxy for expected earnings. As an explanatory variable we use an index measuring annual report disclosure quality. This measure of disclosure is combined with a proxy for the accounting policy choice of the firm. We measure firms' conservatism using the modified Jones model of Dechow et al. (1995) to estimate discretionary accruals. Our results confirm that the relationship between disclosure and cost of capital is affected by the choice of accounting policy.     

Factor Copula Approaches for Assessing Spatially Dependent High-Dimensional Risks

In this article, we propose an innovative approach for modeling spatial dependence among losses from various geographical locations. The proposed model converts the challenging task of modeling complex spatial dependence structures into a relatively easier task of estimating a continuous function, of which the arguments can be the coordinates of the locations. The approach is based on factor copula models, which can capture various linear and nonlinear dependence. We use radial basis functions as the kernel smoother for estimating the key function that models all the spatial dependence structures. A case study on a thunderstorm wind loss dataset demonstrates the analysis and the usefulness of the proposed approach. Extensions to spatiotemporal models and to models for discrete data are briefly introduced, with an example given for modeling loss frequency with excess zeros.     

Measuring Compliance with the Golden Rule

The golden rule of public finance is based upon the notin that intergenerational equity requires that the cost of public expenditures be spread over time in a manner that reflects the intertemporal distribution of the benefits generated by those expenditures. This is often translated into a rule that the budget be structurally balanced in accrual accounting terms. This article considers the form of accrual accounting that is most suited to the task of measuring the consistency of fiscal policy with the golden rule. It recommends a combination of the real capital maintenance approach (also known as ‘current purchasing power accounting’) and annuity depreciation. Such an approach differs from ‘current cost accounting’, which has dominated public sector models of accrual accounting in recent years. The meaning of balance-sheet measures is also considered, and it is concluded that the golden rule is more appropriately expressed as an accrual balanced budget requirement than as a requirement for the maintenance of constant net worth. JEL classification: H6, M40.     

Capital Allocation in Financial Firms

This paper develops a theory of capital allocation in financial intermediaries where the cost of "risk capital" is a critical consideration. The implication for capital budgeting is that financial firms should use a modified NPV rule in which projects are valued by calculating the NPV of cash flows using marketdetermined discount rates and then subtracting a deadweight cost of capital that reflects the project's marginal contribution to firm-wide risk.
By taking account of deadweight costs—mainly monitoring and moral hazard costs associated with having too little equity capital as well as "free cash flow" agency costs and higher taxes associated with having too much—the capital allocation model predicts that financial firms will diversify across businesses with similar deadweight costs. Such diversification reduces the cost of risk capital for the individual businesses, thereby creating more profitable investment opportunities at the margin and enabling the businesses to operate on a larger scale. The authors note that their model has similarities to but also important differences from the standard applications of RAROC models.     

Investment-Based Cost Accounting as a Fundamental Basis of Decision-Oriented Management Accounting

Decision making concerns over cost allocations, especially common cost allocations, have a long history. They are well canvassed in Thomas (1969 ) and Wells (1978 ). This article revisits the cost allocation debate, albeit in a new setting, and rehearses arguments relevant to long- and short-term decision contexts. Here a means is proposed to address those problems, namely to adopt the investment-based approach to cost accounting. This approach draws on ideas of Hotelling (1925 ), Preinreich (1938 ) and Schneider (1961 ), and applies the notion of net present value in another setting, namely to cost accounting theory. Research has revealed no discussion of this in the Anglo-American literature. This article shows analytically that the investment-based approach offers a general basis for decision-oriented cost accounting, as it combines investment theory with cost accounting and thereby connects long-term with short-term decisions. While reviewing primarily European literature, it also examines several Anglo-American works. The analysis reveals how for three classical decision problems—production program planning, purchase order lot sizes, and break-even price limits—two different types of costs, namely depreciation and material costs, have to be based on cash flows and net present value. The proposed investment-based approach permits an examination of the extent to which cost accounting concepts and cost information are relevant to those decisions. This theoretical concept is used to derive pertinent cost dimensions and to solve traditional problems of cost allocation. A caution is that the investment approach is limited to decision facilitating cost accounting. Whether it may be possible to couple it with agency theory and its focus on decision influencing has not been explored and is an issue for further research.     

财务管理中净现值表达式研究

针对目前国内财务管理教材中净现值(NPV:Net Present Value)表达式的现状,从理论角度出发,深入分析净现值不同表达式使用前提、适用范围及其存在的不足。在此基础上,借鉴并结合国内外文献对净现值表达式的研究,最终在理论上对净现值一般表达式进行完善,力求对净现值一般表达式有更深入的理解和把握。     

Time to build,option value,and investment decisions

Investment decisions and outlays are often made sequentially. For example, the rate at which construction proceeds is usually flexible and can be adjusted with the arrival of new information. Traditional discounted cash flow methods which treat the pattern of investment as fixed ignore this flexibility and understate the value of the project. This paper uses contingent claims analysis to derive optimal decision rules and to value such investments. We determine the effects of time to build, opportunity cost and uncertainty on the investment decision. For reasonable parameter values, we show how a simple NPV rule can lead to gross errors.     

基于碳税下的供应链碳减排融资决策研究

全球变暖日益加剧,为实现低碳理念,政府根据碳排放量征收碳税.为响应国家的低碳号召与节省缴税,供应商将进行碳减排投资,而我国中小企业居多的现状使得其必须进行碳减排融资.针对供应商向零售商进行内部融资的情形,在分散决策和集中决策下,运用两阶段Stackelberg博弈理论,根据供应链利润最大化条件进行优化.结果表明:分散决策下,低碳税率和供应商超额收益率的升高以及零售商净机会成本率的降低均会导致供应链总利润升高,单位碳减排量成本的升高会导致供应链总利润的降低,且集中决策的供应链总利润高于分散决策.     

An application of opportunity cost for a short-run pricing decision

This article illustrates how opportunity cost can be provided as an explicit information item for a manager's short-run pricing decision. By using an example of a special order decision situation, the article shows the merits of using an opportunity cost approach instead of using only a direct cost or an absorption cost approach.     

绿色信贷政策得不偿失还是得偿所愿？——基于资源配置视角的PSM-DID成本效率分析

党的十九大报告聚焦生态文明体制改革,明确提出了发展绿色金融的战略要求。商业银行作为实施绿色信贷政策的主体,更加关注因此而产生的成本效率问题,即考量银行自身是得不偿失抑或得偿所愿？本文基于2005—2017年间73家中国商业银行的数据,首先,运用SFA模型测算商业银行的成本效率;其次,运用倾向得分匹配—双重差分法(PSM-DID)实证分析绿色信贷政策对银行成本效率影响的净效应;最后,采用边际动态检验方法考察绿色信贷政策净效应的影响趋势。文章发现绿色信贷政策的实施会通过成本效应机制降低银行成本效率,但同时因其改善了银行的信贷风险管理、提升了银行的声誉,从而对银行成本效率施加正向影响。此外,文章还发现绿色信贷政策的净效应呈现U型趋势,表现为2007—2013年绿色信贷政策净效应负向影响加深,2014年后出现转好信号,现已越过U型谷底。因此,从长期看,绿色信贷政策将有利于银行成本效率提升。