Showing papers on "Physical capital published in 1978"

Capital investment and financial decisions

Abstract: CAPITAL BUDGETING. The Goal of the Firm. Capital Budgeting: An Overview. The Economic Evaluation of Investment Proposals. Net Present Value Versus Internal Rate of Return. Using Cash Flows to Evaluate Investments. Traditional Measures of Investment Worth. Managing Working Capital. RISK AND UNCERTAINTY. Foundations of Risk Analysis. Measuring Risk. Applications of Risk Analysis. Decreasing Risk by Diversification: The Portfolio Approach. The Capital Asset Pricing Model and Arbitrage Pricing Theory. LONG-TERM FINANCIAL DECISIONS. Financial Leverage. Capital Structure and Valuation. Bankruptcy Risk and the Choice of Financial Structure. Defining the Cost of Capital. Measuring the Cost of Capital. Dividend Policy. Options and Futures. The Lease or Buy Decision. Mergers. International Financial Management. Appendices. Index.

The Welfare Cost of Capital Income Taxation

Abstract: The paper begins with a critical examination of four mistaken propositions that characterize much of the conventional wisdom on capital income taxation. The analysis then shows the correct approach to evaluating the welfare cost of alternative tax treatments of capital income when taxes affect both the supply of labor and the timing of consumption.

Government Debt, Human Capital, and Bequests in a Life-Cycle Model

Abstract: In a Samuelson overlapping-generations model, conditions for an operative interegenerational transfer motive are derived without special assumptions about the form of the utility function. Crucial in determining if transfers will be positive is the rate at which individuals discount heirs' utility relative to the market interest rate. It is also shown that transfers of human capital (such as investment in education) are not equivalent to ordinary bequests for the bonds-as-net-wealth controversy. If intergenerational transfers take the form of human capital, issuance of government bonds or social security can affect the equilibrium solution, even if the transfer motive is fully operative.

The Cost of Capital and the Market Power of Firms

Abstract: RECENTLY, significant research has been conducted on the functioning of the capital market. One thrust of this research (e.g., Fama, 1970) has demonstrated that the capital market is highly efficient, i.e., the prices of securities at a point in time seem to reflect available information, and security prices seem to adjust quickly over time to new information. Another thrust (e.g., Sharpe, 1964; Lintner, 1965; Mossin, 1966; Jensen, 1972) has been the theoretical development and empirical testing of a specific model, the Capital Asset Pricing Model (CAPM), which precisely defines risk and return, gives an economic justification for diversification, and under specific assumptions draws the equilibrium conditions between risk and return in the capital market. Not withstanding serious econometric difficulties of estimation, these studies picture a highly efficient capital market in which capital funds are allocated based only upon risk and return considerations as determined by a rigorous evaluation of relevant information. The capital market depicted in this recent capital market literature would seem to differ from the capital market depicted in the literature of industrial organization economics. For example, Baumol (1967) and Hall and Weiss (1967) have argued that the major barriers to entry are not in the structure of output markets, but in the capital market. The argument is that to enter and compete effectively in many basic industries, such as automobiles, chemicals, etc., a large sum of capital is necessary, and the capital market will not allocate a large sum to a new entrant. Basically the capital market fails in its allocative function because investment opportunities, albeit opportunities with high profit potential, are "lumpy." That is, investment opportunities cannot be financed in small discrete amounts by new entrants, but can only be financed in large amounts by existing firms insuring basic industries marked by large firms with high market shares. Both the capital market literature and the industrial organization literature are valuable reference points for those who would hope to understand the allocation of capital in the economy and the effects it has upon the condition of entry, level of price and level of output found in industrial markets. The general purpose of this paper is to begin a reconciliation of these literatures with respect to their disparate views of the capital market. Since capital market theory relates capital costs to risk, our specific purpose is to determine if the market power of firms, as measured by size and seller concentration, seems to reduce the riskiness of firms and therefore their capital costs. In section II the difference between book profits and capital costs is stated. In section III, with the aid of the Capital Asset Pricing Model, the relationship between capital costs and risk is presented. In section IV the data and sample of firms are described, and in section V the data analysis is presented, which does in fact suggest that the risk and capital costs of powerful firms are lower than for other firms. Conclusions are presented in section VI.

The cost of equity capital with personal income taxes and flotation costs

Abstract: THIS PAPER ESTABLISHES the cost of retention-financed capital and the cost of stock-financed capital in the presence of personal income taxes and flotation costs under alternative theories of share valuation that are considered plausible. In the absence of the tax and flotation costs (and information content to the dividend), the cost of equity capital is independent of its source. It then depends on whether a share's yield is independent of (SYI) or is dependent on (SYD) the firm's investment decision. It also depends on whether the return on investment functions in future periods are independent of (RIFI) or are dependent on (RIFD) the firm's current investment decision. Consequently, under the conditions stated there are four possible answers to the question, what is a corporation's cost of equity capital? Each of the pairs (1) SYI-RIFI, (2) SYD-RIFI, (3) SYI-RIFD, and (4) SYD-RIFD results in a different answer. Part I reviews these four solutions to the cost of equity capital. Part II extends the four solutions to establish the costs of retention-financed and stock-financed capital in the presence of flotation costs and the differential tax treatment of dividends and capital gains. Part III compares the results obtained with the existing literature. All that a search of the literature could find is the Lewellen [6] solution to the problem. That solution was confined to the SYI-RIFI case, and it assumed the pre-tax share yield is independent of the firm's investment decision. In fact, when the no-tax share yield is taken to be independent of the firm's investment decision, it is the after-tax share yield that takes on this property. The pre-tax share yield becomes a decreasing function of the dividend's rate of growth, and the Lewellen solution materially understates the costs of retention-financed and stock-financed capital under the SYI-RIFI assumptions. I. The cosft of equity capital depends on whether the return on investment functions in future periods are dependent on (RIFD) or independent of (RIFI) the firm's current investment decisions. We will first examine the cost of equity capital models under each of these assumptions in the absence of personal taxes and flotation costs.

Some aspects of technology transfer and direct foreign investment

Abstract: A model showing technology transfer to developing countries links questions of appropriations with the socio-economic reasons for technological change. The rate at which foreign capital is used is found to be directly related to after-tax profits. If the developing country raises taxes on foreign capital, the effect is to increase the proportion of domestic capital needed and to widen the technological gap between the two countries. The analysis also shows a higher gain from new techniques with increased demand volume and suggests large developing countries with similar capital to invest are more likely to generate intermediate technologies. 8 references.

Risk, Human Capital, and the Investor's Portfolio

Abstract: The twin theories of investment in human capital and management of marketable assets have developed along two remarkably independent paths. Models of investment in human capital have without exception ignored the closely related problem of managing portfolios. This has been possible only because until very recently the literature on human capital has largely avoided the important issue of uncertainty. Simultaneously, the literature on portfolio theory has essentially ignored human capital. Currently, no model of investment in risky marketable assets includes endogenous allocations to education.' In this paper, risky human capital is introduced into a two-period, mean-variance portfolio problem. As in Levhari and Weiss (1974), the basic theoretical model is simple, permitting easy identification of the various effects of uncertainty. Here, however, in contrast to previous work, the Opportunities for risky investment in education are introduced into a two-period, meanvariance portfolio problem. Uncertainties arising from expenditures on education have three sources: ambiguous inputs in the production of skills, a risky rate of depreciation or obsolescence of existing skills, and a stochastic future wage. Properties of efficient and optimal investments in securities and education are derived in detail with special emphasis on education.

Problems with the Concept of the Cost of Capital

Abstract: The cost of capital concept has for some years permeated both finance theory and textbook treatments of capital structure and business investment decisions. This has been due, to a major extent, to the important works of Modigliani and Miller [10,11] and Solomon [16], among others. In recent years, however, the concept has been the subject of some controversy. A number of authors have shown that the cost of capital, as usually computed, can produce errors except under highly restrictive assumptions and that there continues to be some debate over its proper definition and use. Our purpose in the present paper is to explicate more fully the source of the difficulties with the cost of capital and to suggest that, despite the initial usefulness of the concept, the field of finance would be better off now if it were relegated to history. Both the perfect and imperfect market cases will be considered. We propose that the term “cost of capital” be eliminated from textbooks and research papers and be replaced by superior concepts.

Debt Capacity, Optimal Capital Structure, and Capital Budgeting Analysis

Abstract: * As far back as 1955, Solomon [9] recognized that capital budgeting decisions should consider the debtcarrying capacity that a proposed capital project adds to the firm. Since then, much work has been done on the nature of debt capacity and its value to the firm. The value of carrying debt was quantified by Modigliani and Miller (MM) [7] in the context of a competitive market with corporate taxes and no insolvency costs. Lewellen [5] further clarified the analysis of debt capacity by considering portfolio effects of an acquisition whose cash flows are less than perfectly correlated with those of the acquiring firm. Building on the MM framework and the capital asset pricing model, Bower and Jenks [1] explicitly incorporated the tax benefits of debt capacity in setting discount rates for individual projects. Martin and Scott [6] extended the Bower-Jenks analysis by expressing debt capacity in terms of a target probability risk of insolvency for the firm. The capital budgeting literature cited does not deal explicitly with the firm's optimal capital structure. This paper seeks to do this and to analyze the implications of optimal structure in capital budgeting decisions.

Inflation and the Excess Taxation of Capital Gains on Corporate Stock

Abstract: The present study shows that in 1973 individuals paid nearly $500 million of extra tax on corporate stock capital gains because of the distorting effect of inflation. A detailed analysis shows that the distortion was greatest for middle income sellers of corporate stock. In 1973, individuals paid capital gains tax on more than $4.5 billion of nominal capital gains on corporate stock. If the costs of these shares are adjusted for the increases in the consumer price level since they were purchased, the $4.5 billion nominal gain becomes a real capital loss of nearly $1 billion. As a result of this incorrect measurement of capital gains, individuals with similar real capital gains were subject to very different total tax liabilities. These findings are based on a new body of official tax return data on individual sales of corporate stock.

Earnings Inequality across Labor Markets: A Test of the Human Capital Model

Abstract: This paper provides a test of the Chiswick-Mincer specification of the human capital model in an analysis of earnings inequality across U.S. labor markets.1 The determination of income inequality across states and metropolitan areas has been examined in numerous studies.2 In these studies, Gini coefficients are used as a measure of inequality and are regressed on a host of economic and demographic variables. Typically, it is found that income inequality is inversely related both to the level of schooling and to the level of income. The former finding is often used to lend support to arguments for increased educational expenditures, while the latter finding is often cited to support the U hypothesis of Kuznets [12] that income becomes more equally distributed during later stages of economic development after having become less equal during early stages. These findings have been replicated using data across cities and states, and have been found to hold at various points in time. However, the theoretical basis for the relationship of inequality with the level of schooling and of income has not been clearly developed.

Estimation of a Vintage Capital Model for Electricity Generating

Abstract: A slightly different way of looking at the traditional model of production applies an hedonic approach to vintage capital in order to resolve and clarify various problems of the traditional model in describing capital goods. In particular, for processes making production constraint is the hedonic price function. Such constraints involve economic as well as technical factors that may make them unstable. Preliminary analysis of the price function for the U.S. steam-electric generating industry indicates poor substitution opportunities at the plant level between equipment, fuel, and labor. Economies of scale in capital costs, using a non-substitution model, are found to be small with respect to plant size, while economies of fuel are large in respect to unit size and economies of scale in labor are substantial for all plant sizes. All the observed improvement in fuel efficiency appears to be due to economies of scale. The number of men required to operate a plant of given size, conversely, has declined steadily. The hedonic price index based on the price function indicates that existing conventional price indices have grossly overestimated the increase in the price of capital equipment as a result of failing to make adequate allowance for quality change. 16 references.

Taxes, Dividends and Capital Gains in the Adjustment Cost Model of the Firm

Abstract: This paper analyzes the shareholders' wealth-maximizing model of the firm which assumes taxation, perfect financial markets and the cost of adjustment on the investment side. The firm's growth path is shown to consist of three separate phases which describe the mutual behavior of dividends and capital gains. An analysis of the effects of tax parameter changes emphasizes the need to distinguish between firms whose growth is constrained financially and those whose growth is contstrained by profitability.

Measurement of Capital Depreciation within the Japanese Fishing Fleet

Abstract: AN important unresolved question in the analysis of capital investment is whether the deterioration of physical capital occurs at a constant exponential rate. (For detailed discussion see both Jorgenson (1971) and Feldstein and Rothschild (1974).) The empirical evidence on physical capital depreciation patterns is inadequate to refute any proposition about the actual decay of capital inputs. On the one hand, analyses of acquisition prices of new and used automobiles by Wykoff (1970) and by Cagan (1965) and of used farm tractors by Griliches (1960) uniformly concluded that the geometric depreciation function adequately characterizes the true depreciation function. On the other hand, Hall (1971) and Feldstein and Rothschild (1974) found statistical grounds for rejecting the null hypothesis of an exponential depreciation function. The major purpose of this paper is to apply the statistical test procedure on the geometric depreciation function developed by Hall (1971) and Jorgenson (1971) to data on Japanese fishing boats. The published Japanese data on the insured value of fishing boats against total loss are adjusted to reflect the assessed market valuation for insurance purposes. These adjusted values are used as proxies for the acquisition prices of new and used fishing boats. These proxy variables can be justified because it is common practice for the insurance companies to minimize the difference between the insured value of capital items and their market or actual replacement value. This is accomplished by annual adjustments of insured values for physical deterioration and technical obsolescence (Lee, 1973). These data form a unique set for comparison with the acquisition price data on used automobiles frequently employed in previous studies. To date, most attention in the literature on capital depreciation has been paid to consumer durables, particularly to automobiles, with the exception of Griliches (1960). By comparison, fishing boats are capital inputs to fishery production activity. In Cagan's (1965) expression, the demand for capital inputs is less likely to be influenced by ephemeral fads and will reflect greater emphasis on innovations of enduring importance than will the demand for consumer durables. In addition, since the assessed market valuation of new boats for insurance purposes is believed to reflect satisfactorily the actual value of new boats, the data should reveal some information on that portion of the lifetime depreciation of a capital asset that takes place during the first year of its life. By contrast, the data constraints of previous studies allowed capital depreciation analyses only for vehicles that were more than one year old. This was an unfortunate and significant omission.' Though the Hall model (1971) is fundamentally under-identified, as will be discussed in detail later, it is still possible to statistically test several typical assumptions regarding the nature of depreciation and embodied technical change that are commonly seen in economic literature. While the results of the test are specific to the Japanese fishing fleet, interpretation of these results along with the results of previous studies should give some indication whether the typical assumptions are empirically Received for publication September 14, 1975. Revision accepted for publication June 23, 1977. * Research Triangle Institute. An earlier version of this paper was presented at the Third World Congress of the Econometric Society, Toronto, Canada, in August 1975. Grateful appreciation is extended to W. Kenneth Poole, Jerome A. Olson, and Allen K. Miedema at Research Triangle Institute for discussion and comments on earlier drafts and to Joanne Turner Rogoff of Research Triangle Institute for her editorial assistance in the preparation of this article. The author also thanks an unknown editorial referee for invaluable comments and criticisms. I Hall (1971) measured the depreciation of half-ton pickup trucks relative to 1-year-old trucks because the prices of new trucks were not available from his sources. Wykoff's (1970) study of acquisition prices of new and used automobiles reveals a sharp drop between the price of new cars and the price of used cars. Jorgenson (1971) contends that Wykoff's finding is attributable mainly to the inadequacy of the list prices of new equipment to reflect the prices paid at actual transactions.

Investors' Time Horizon and the Inefficiency of Capital Markets

Abstract: I. Introduction, 187.—II. The monopoly problem 189.—III. Monopolistic value maximization, 195.—IV. Some remarks on financial uncertainty, 202.—V. Conclusion, 204.

Indentured Servitude: The Philadelphia Market, 1771–1773

Abstract: In the 1770s Philadelphia had a well developed indentured servant market which served the city and the surrounding region. This market had many attributes of rational labor and physical capital markets and provided a means for financing migration and education. This study is of indenture records which include prices, term lengths, employer-provided amenities, and servant attributes to test hypotheses based on a rational buyer model. Results indicate that in response to the riskiness of a servant, the buyer used indexes of servant productivity and reliability; that the servant paid for amenities offered by the master, such as general education; and that there was a seasonal pattern of prices corresponding to seasonal activities of agriculture.

A representation of Canadian manufacturing technology

Abstract: Both capital and labor are disaggregated in this analysis of production technologies in Canada in order to more accurately assess the economic impacts of change, particularly policy changes. Factor share demand functions are estimated for the 1950 to 1970 period and compared with other studies, which are found to be less useful because of the inseparability of capital and labor inputs. The benefits of disaggregation are found to include better estimates of price elasticities and partial elasticities of substitutes as well as more accurate forecasting of capital market behavior. The effects of recent investment tax credits are found to promote capital substitution for labor, with the greatest impact felt by production workers. 33 references. (DCK)

Earnings, occupation, and human capital investment

Abstract: In recent years the human capital earnings model has been widely used as a framework for examining the determination of earnings. A specification of the human capital earnings function developed by Chiswick and Mincer has been employed to examine earnings determination across individuals [Mincer, 1974b], states [Chiswick, 1974], metropolitan areas [Hirsch, 1978], occupations [Rahm, 1971], and over time [Chiswick-Mincer, 1972]. However, empirical studies utilizing the human capital framework have assumed that the effects of workexperience (postschool investment) on earnings are identical for individuals, regardless of occupation. This assumption runs counter to the current emphasis of many labor economists on the importance to lifetime earnings of gaining early access to certain occupational job ladders and of receiving firm specific on-the-job training [Doeringer and Piore, 1971 ; Thurow, 1975]. Likewise, human capital economists stress the importance of postschool training investments and at least recognize the fact that these investments vary across occupations. Indeed, Mincer has stated that [Mincer, 1974a, p. 33] : "an analysis in which these effects [of schooling and of experience] are allowed to differ [across occupations] would be desirable for a number of purposes, not the least of which is an insight into differential post-school job skill investments." This paper examines whether schooling, experience, and weeks worked have different effects on individual earnings in nine separate occupational categories. The Chiswick-Mincer spec*University of North Carolina at Greensboro. The research is drawn in part from my doctoral dissertation on which William R. Johnson and Roger Sherman provided helpful comments. Support by a doctoral dissertation grant from the U.S. Department of Labor, Employment and Training Administration, is gratefully acknowledged. ification of the human capital earnings function is modified in order to focus on differences across occupations in their earnings-experience profiles. This makes possible several inferences regarding the intensity, length, and rate of return to postschool human investments across occupational job ladders. In addition, we examine the manner in which occupation interacts with schooling in the earnings generation process and discuss analytical problems which arise in modeling this process. Finally, the relationship between wage rates, weeks worked, and occupation is examined. The Theoretical Framework

The meaning of capital

Abstract: THE controversies over so-called capital theory arose out of the search for a model appropriate to a modern western economy, which would allow for an analysis of accumulation and of the distribution of the net product of industry between wages and profits.

Firm size, factor intensities, protection and the sectoral patterns of West German manufacturing investment in less developed countries

Abstract: It is the purpose of this paper to test the following hypotheses concerning the impact of firm size, factor intensities and protection on the sectoral allocation of West Gentian manufacturing foreign direct investment (FDI) in less developed countries (LDCs): Hyp.I: The branches' propensity to invest in LDCs is the higher, the higher the average size of firm within the respective branches. Hyp.II: The higher a branch's human capital intensity, the lower its propensity to invest in LDCs. Hyp.Ill: Rising physical capital intensity induces increasing FDI in LDCs. Hyp.IV: The higher the branches' imported raw material intensity, the lower their propensity to invest in LDCs. Hyp.V: The higher a branch is protected against competing imports from LDCs, the lower its propensity to relocate production to LDCs.

The Rental Cost of Capital for the Manufacturing Sector-1959-1960 to 1970-1971

Abstract: Pakistan, like other under-developed countries, is faced with a situation where factor prices do not reflect their scarcity values, thereby leading to a waste of valuable resources in the form of highly capital intensive techniques and excess capacity in the manufacturing sector. Low costs of using capital in Pakistan have been attributed to a combination of factors e.g. low rates of interest, overvaluation of domestic currency, low tariffs on machinery imports. and fiscal incentives such as tax holidays and accelerated depreciation aimed at encouraging investment. In this paper a formula incorporating the effect of various such policy packages on the cost of capital has been used to estimate the market and "real" rental cost of capital over time (1959-1960 to 1970-1971) providing a measure of the degree of distortion introduced into the factor market via government policies.