# [OPE-L:7381] [OPE-L:911] Re: Discounted Prime Costs

John R. Ernst (ernst@PIPELINE.COM)
Thu, 15 Apr 1999 18:34:18

Paul, RE: OPE-L 882

Again, thanks for an example (See below.). We're obviously not
on the same wave length but perhaps this is a way to
get somewhere. With the "old investment in competition with
with new", I see that one is required to invest 240 for
a 5 year period in order to receive 5 annual payments of
90. With the new investment, one must invest 420 for a
seven year period to receive 7 annual payments of 90.
Which is the better investment? The rate of return I
compute for the older is 25.4% and for the newer a rate
of 11.3%. To get these figures, I simply used the
equation

90/(1+r)+90/(1+r)^2+90/(1+r)^3+90/1+r)^3+90/(1+r)^4+90/(1+r)^5=240

and solved for "r" by iterating. In a similar fashion, I set
up an equation and solved for "r" for the newer investment. I
don't see a problem with this way of evaluating investments but
am willing to listen criticisms and comments.

"My" method makes some sense to me since with the old investment
one invests 240 and makes 210 (5*90-240) in 5 years. With the
new investment, one invests 420 and makes 210 in 7 years (7*90-420).
It's clearly better to make 210 in 5 years rather than 7.

John

Paul's Example

old old in comp with new new
const cap 100 200 400
life 5 5 10
dep 20 40 40
raw mat 10 20 10
wages 10 20 10
output physical 1 2 2
prime cost 40 40 30
value 50 50 35
price 50 45 45
profit 10 10 30
capital 120 240 420
rate of prof 0.083 0.041 0.071
discount rate 0.04 0.04 0.04
Interest paid 4.8 9.6 16.8
p of e 5.2 0.4 13.2
disc pc 44.8 44.8 38.4

What we have here is a fall in the value of the product
a fall in the rate of profit even with the new technique,
but it is favourable to adopt it because the discount
rate is sufficiently low.
This, I think, is what actually occurs when a rising
organic composition leads to a falling rate of profit.
The fact that the rate of interest is below the
rate of profit allows the underlying reduction in
value to offset the higher capital stock required
for the new technique.
Paul Cockshott

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