Question

Explain each of the determinants of the present value of expected profits from buying a new machine.

Answer 1

The present value of expected profits depends on the profits expected to be earned as a result of buying the machine (in years t+1, t+2, and so on), the depreciation rate of the machine each year it is in operation, and the current and expected real interest rate. An increase in the profits expected will lead to an increase in the present value of expected profits. An increase in the rate of depreciation or an increase in current or future expected real interest rates would decrease the present value of expected profits.