No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Sixteen: Valuing the Future - Concepts in Capital & Finance 417 CHAPTER SIXTEEN ANSWERS 1. False; lease holders were commanded to return property once their lease had expired (since they were only allowed to pay a lease payment for the number of years left until the Jubilee). 2. True. 3. False; it only becomes a capital good in the plans of entrepreneurs. Otherwise, it might just be a fun toy. 4. False; it means that a capital asset has particular uses and may not have good (or any) alternate uses. 5. False; all plans must change as time progresses and new knowledge is gained. 6. False; the problem is not too much capital, but the wrong kind of capital (due to capital heterogeneity—this would not be a problem if capital was homogenous) 7. False; there is hopefully a viable investment strategy. The only sense in which we say an investment strategy is optimal is, given the knowledge we have today, our expectation is that a given strategy is the best of available options. 8. Since cash flows in the future are worth less than cash today, the value of future cash flows must be “discounted” to compare to amounts of cash today. 9. 12% or 72/6. 10. Fundamental value is equal to the present discounted value of all future net cash flows. 11. Lower interest rates make any future cash flow more valuable, because as you discount the future cash flow back to the present, the lower interest rate increases the value of the future cash flow. So longer-lived capital assets benefit more than short- lived capital, as they have more future cash flows that benefit from the lower interest rate. 12. Uncertainty means that at best, our calculations of present value are our best guess, and as new knowledge of the future is gained, we will need to continually refine our estimates. Entrepreneurs that more accurately forecast the future will earn superior profits. 13. For finance, we are still concerned with variability of returns, which is what risk is defined as in finance. This is a different way of thinking about risk than we’ve previously learned (that a probability distribution of all possible outcomes can be known). Nevertheless variability of returns is based on past data (the best entrepreneurs really have), yet as new knowledge is gained, each return in the future is an unknown, unique event. As Lachman said, the future is unknowable, but it is not unimaginable.