§7. Other Similar Illustrations

Both the preceding examples, one of intensive agriculture and the other of forest cutting, involve (1) an immediate cost and (2) a return one year later, thus reducing the marginal rate of return over cost to such simple calculations as (105 - 100) ÷ 100 = 5 per cent.

We may vary the illustration indefinitely and still preserve this elementary simplicity. A merchant has always before him an indefinite number of possible income-streams from which to choose. As in the case of the land cultivation and the forest cutting we may simplify his choice by supposing successive doses of costs of $100, each spent on more or better machinery, more or better workmen, more or better advertising, more or better supervision, and so forth, each $100 cost being immediate, and then supposing the returns to these successive doses of invested cost to come respectively one year later and to be respectively, say, $140, $130, $115, $106, $105, $104; so that the excess of return over the cost will be respectively $40, $30, $15, $6, $5, $4. Thus the rate of return over cost will be respectively 40, 30, 15, 6, 5, and 4 per cent. The enterpriser will incur the costs as long as the rate of return over these costs is greater than the market rate of interest. In this case, therefore, he will stop at 5 per cent if the market rate of interest is 5 per cent. Again we have ($105 - $100) ÷ $100 = 5 per cent.

In practice, however, we seldom, if ever, have such simplicity in calculating the rate of return over cost and there are innumerable other types of contrast between the successive income streams which may be at the same time under consideration by the investor.

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