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marginal efficiency of capital
Marginal efficiency of capital (MEC) refers to the expected rate of profitability of new investment. MEC is calculated based on the amount of expected profit and the cost of the capital asset. It indicates the internal rate of return of an extra unit of capital. Investment decisions are influenced by comparing the MEC to interest rates - investments will be made when MEC is higher than interest rates. Companies use MEC to evaluate investments by comparing the discounted present value of expected income to the price of the capital asset. The document then discusses factors that affect MEC and provides a case study of how Nike used MEC to evaluate an investment decision.
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Introduction to Marginal Efficiency of Capital (MEC), key factors, and overview of contents.
MEC represents expected profitability from new investments, determined by profit amount and capital cost.
Key factors affecting MEC: cost of capital, demand for goods, tax rates, finance availability, expectations, and technological innovation.
Relationship between MEC and interest rates; investment decisions based on ROI in relation to MEC.
Example of capital maintenance using MEC in a machine investment; case study of Nike's expansion using MEC.
Conclusion of the presentation and acknowledgement.
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marginal efficiency of capital
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- 2. SYNOPSIS • Introduction • Marginalefficiency of capital. • Factors effecting MEC • MEC and interest rates • How companies maintain Capital using MEC • Case study • Conclusion
- 3. INTRODUCTION Irving Fisherwas first economist to make use of concept MEC in 1920. He gave it a name Rate of return over cost. Simply MEC means “expected rate of profitability of new investment”. It’s calculation depends upon two factors mainly I. amount of profit II. cost of capital asset
- 4. MARGINAL EFFICIENCY OF CAPITAL The marginal efficiency of capital (MEC) is that rate of discount which would equate the price of a fixed capital asset with its present discounted value of expected income. In short, MEC is the internal rate of return of an extra unit of capital. The theory of marginal efficiency indicates that investment decisions will be influenced by: I. The marginal efficiency of capital II. The interest rates
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- 6. Factors Affecting theMarginal Efficiency of Capital Marginal Efficiency of Capital Cost of Capital Demand for goods Marginal rate of Tax Availability of Finance Expectations and confidence Technological Innovation
- 7. Factors Affecting theMarginal Efficiency of Capital 1. The cost of capital: If cheap capital is available for investment, then investment opportunities become more attractive.
- 8. Factors Affecting theMarginal Efficiency of Capital 2. Demand for goods and services If tastes and preferences change and demand for a good increases, then the increased demand is likely to increase profitability. 3. The marginal rate of tax If the marginal rate of tax is increased then the net return on an investment will fall, reducing the marginal efficiency of capital. 4. The availability of finance Restrictions on lending will limit investment. A relaxation of credit controls will make investment easier.
- 9. Factors Affecting theMarginal Efficiency of Capital 5. Expectations and confidence If people believe that growth in economy is slowing and unemployment may rise in the foreseeable future, then demand in the economy may contrast. 6. Technological change Innovation in products or processes may increase the potential size of the market or help to drive down costs.
- 10. MEC AND INTERESTRATES An investor while taking an investment decision makes a comparison between MEC and rate of interest. when ROI is less than MEC (ROI<MEC) investor make more investment. When ROI is more than MEC (ROI>MEC) no investment will be made. When ROI is equal to MEC (ROI=MEC) investor stop making any more investment.
- 11. HOW COMPANIES MAINTAIN CAPITALUSING MEC EXAMPLE: • Suppose the price of machine is 30000.Duration of life of machine is 10 years, expected income during this period is 60000. NOW Total Profit of machine is 60000-30000= 30000 Average profit per year - 30000/10 = 3000 MEC = 3000/30000 *100= 10%
- 12. CASE STUDY • Thisis case is about Nike which is a popular brand in sporting apparel division. • Nike generated 2.81billion$ in operating income on revenue of 20.9billion$ in FY 2014 end of may. • Nike planning on expansion in to fashion apparel segment. • 2.5billion$ is capital investment (marginal capital) they are going to invest. • Expected market share will be at 2% in first year. • Gross profit margins are expected to be a 23% of revenues. • Total time period is 12 years. • Nike has used MEC for taking decision on expansion plan investment .
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