1. Value Maximization Economics 134A

2. Prerequisites  PSTAT 5E, Economics 100AB or 104AB, Econ 101 or permission.  Otherwise, see Marshall in office hours for permission to enroll. Tuesday-Wednesday 1-2, NH 3044.

3. Course web page  www.econ.ucsb.edu/~marshall

4. Start immediately to learn a spread sheet.

5. Key concepts of problem solving  Equivalence (usually in present value, occasionally in rate of return)  Optimization (choice of action)  Aggregation (of values of cash flows)

6. Webservice.com  Example of valuation for a start-up

7. Key concepts for today  Real investment  Financial investment  Separation principle

8. Terminology  Real investment = buying physical capital  Financial investment = trading one asset for another  e.g., money for shares of stock

9. Principle of separation  Present discounted value the real investment. (equivalence).  Decide whether to undertake it (optimization).  Select the appropriate financial investment or disinvestment (optimization).

10.  Time one is the future.  Notation:  Cash flows at times zero, one  Prices of those cash flows in current dollars. Time zero is the present

11. Interest rate defined  Premium for current delivery

12. Interest rate defined  Price of future money in terms of current money

13. Interest rate applied  Prices of future dollars in terms of current dollars.

14. Review question  A standard question for midterm or final: Suppose the owner of a firm has a good investment opportunity that uses all of her cash. She wants to consume right away. Which should she do? Explain.  Answer: do both.

15. Demonstration: Monty Hall  A prize is behind one of three doors.  Contestant chooses one.  Host opens a door that is not the chosen door and not the one concealing the prize. (He knows where the prize is.)  Contestant is allowed to switch doors.

16. Solution  The contestant should always switch.  Why? Because the host has information that is revealed by his action.

17. Representation Nature’s move, plus the contestant’s guess. pr = 2/3 guess wrong guess right pr = 1/3 switch and win or stay and lose switch and lose or stay and win