Input decision criterion refers to the rules that guide individuals, manufacturers and governments to make reasonable input decisions. For your convenience, let's take a look! Let's share with you what the investment decision criteria are. Welcome to read!
Input decision criteria
Input decision criterion refers to the rules that guide individuals, manufacturers and governments to make reasonable input decisions. The reason for these formal rules is that these inputs involve comparing the future benefits of the crisis with the costs that are known to be paid now. Time, crisis and traditional costs (such as labor) are all things that should be considered before making rational investment decisions.
Enter the content of decision criteria.
The classic input problem only involves one person, and it is an RflbinsanGrusoe-style economy. In this problem, Crusoe must decide how much fixed labor he should devote to collecting coconuts and other edible foods and how much time he should devote to processing tools. The more time Crusoe spends on machining tools, the better off he will be in the future. However, judging from the current consumption, his situation will be even worse. Assuming Crusoe is rational, he will allocate the amount of labor for the input at a certain point, which is his income from the subjective evaluation of the future crisis from the extra input, which is exactly equal to his subjective evaluation of consumable consumption.
In a multi-person economy and a perfect and complete capital market, rational investment decisions can be made on the basis of interest rates: decisions are independent of individuals' subjective evaluation of paying future crisis benefits now. In a sense, whether investors are individuals, manufacturers or governments, the message conveyed by interest rates is that they need to compare the benefits of future crises with the costs they have to pay now. This is the so-called separation phenomenon.
In the absence of transaction costs such as brokerage fees and securities transaction taxes, the capital market can be said to be perfect. When the capital market contains all possible financial securities, it can be said to be a complete market. The real world capital market, even in the United States, is not perfect and complete. From almost perfect US Treasury bonds and common stock of large enterprises to far from perfect real estate market and human capital market. Similarly, in many parts of the world, capital markets are almost non-existent.
One of the most common rules of input decision-making is the principle of net current price. In an independent investment project, the present value of the future income minus the initial input cost is defined as the net present value of the project. This principle says that the net present value of a project must be positive. A project has a positive net present value, which means that the present value of its future crisis income exceeds its cost. The net present value principle is a special cost-benefit test.
The way to convert future cash income into present value is to multiply it by a coefficient. This coefficient is based on the required rate of return and the time to obtain the income. The required rate of return is the rate of return obtained by investing in securities with the same crisis. For example, if there is a profit of $ 100, you will definitely get it within one year. Because of the high certainty, the appropriate coefficient should be determined by the yield of US Treasury bonds. If the yield of US Treasury bonds is 8%, then the coefficient should be 1/( 1+0.08), which is 0.9259. So the present value of one year 100 dollars is 92.59 dollars. It is worth noting that the present value of future income is always less than its face value. In fact, the longer it takes to gain income, the smaller its present value; The more benefits in the future, the greater the crisis.
The second input decision criterion is the principle of internal rate of return. The internal rate of return of investment plan refers to the rate of return when the present value of future income is exactly equal to the initial input cost. This principle should choose those investment plans whose internal rate of return is greater than the required rate of return.
In those "normal" input projects where initial input and expenditure will inevitably bring positive cash flow, the internal rate of return and net present value are mathematically equivalent in principle. Please note that if the net present value of an input project is zero, its required rate of return must be its internal rate of return. Because at this time, the present value of its future income is exactly equal to its initial input and expenditure.
In some cases, the principle of internal rate of return and net present value are mathematically equivalent. The similarity of these situations is that the future income will change constantly. One example is that continuous positive income is followed by negative income, so in order to reduce costs, we have to stop investing. According to the philosopher Descartes' "symbolic principle", this kind of investment project should have various internal rates of return. At this point, the internal rate of return principle has lost its original economic significance.
In addition, in the face of several mutually exclusive investment projects, we should give priority to the projects with higher net present value rather than the projects with higher internal rate of return. This rule is very obvious when comparing investment projects of different scales. An investment of $ 1000000 means more money if its profit exceeds cost 1%, which is more attractive than an investment of $1000.
The third input decision criterion is payback period. This standard is very simple, that is, to compare the time required to recover the initial investment cost. Such a simple and clear rule conceals the fact that it only considers a small part of the data in the project. Its simplicity will make people regard the payback period criterion as a criterion superior to computer calculation. Because the use of modern computers has greatly reduced the cost of using more complex but more accurate rules, this payback period rule should be considered outdated.
Application of input decision criteria
The most obvious application of input decision criteria is the process of formally analyzing and approving capital expenditure, just as most large enterprises are implementing it. These programs not only specify which input decision criteria to use, but also often guide the prediction of key variable cost projects. The investigation of current actual business practice shows that people are increasingly using internal rate of return and net present value standards instead of relatively easy but inaccurate payback period standards.
When input and expenditure are limited by capital budget, people often use another decision-making standard. This decision-making standard is changed from the net present value standard, which is called profitability index. Profitability index is the ratio of the present value of future income of investment plan to its initial investment cost. If there are multiple investment plans, they all have hard present values, which are all within the capital budget. However, the capital budget cannot support so many plans at the same time. At this time, the best solution that can be achieved should be the one with the highest rate of return.
Theoretically, the principle of net present value should be applied to public investment and infrastructure investment, such as dams, irrigation and other water conservancy projects, just as it is applied to private investment decisions. The application of cost-benefit analysis will involve the comparison between future crisis benefits and current costs. When evaluating public investment projects, we will encounter a special problem, that is, how to quantify the future benefits. Because the prices of these goods and services are not available in the market. In addition, when the artificially low interest rate is used to prove the maximum number of projects that should be implemented, political pressure may be encountered. Due to the difficulties in applying net present value and other similar standards in public investment, subjective evaluation based on "requirements" may be used.
Here are two special examples of internal rate of return applicable to bond and stock markets. The first is the yield, more precisely, the yield of bonds. Since a bond has a market price (whether higher or lower than its face value), its promised interest, principal and income represent the internal rate of return of the bond.
The second special case is the price-earnings ratio of common stock. P/E ratio is the market price of common stock divided by the earnings per share of the enterprise. P/E ratio is the reciprocal of income-price ratio. The ratio of income to price can be interpreted as the internal rate of return of ordinary stocks. When a stock has multiple of price income, the enterprise that issues the stock correspondingly has lower necessary rate of return. This is because at this time, the market thinks that this enterprise is in good financial condition and has a good profit growth prospect.