Involves calculation and component that support cost of capital

1. ECO
206
GROUP 04.

2. PRESENTATION OUTLINE
INTRODUCTION
MAIN DISCUSSION
COMMENTS ON ANSWERS

3. Consider Fred’s investment in units of health capital with the
following function:
𝐼 = 500 − 1,000 × 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑐𝑎𝑝𝑖𝑡𝑎𝑙
A) Indicate some of the components of the cost of capital, and
why they are costs.
B) If the cost of capital is 10 percent each year, what is the
equilibrium health investment in terms of units of capital?
What is the equilibrium total investment expenditure?
Explain both answers.
C) If the cost per unit of health capital doubles to 20
percent, what will happen to the equilibrium level of
health investment and to equilibrium health investment
expenditures? Why?
QUESTION

4. INTRODUCTION
• The cost of capital refers to the expenses that a
company incurs in order to obtain financing for its
operations. Investment in healthcare for
medicinal services segment is comprised of
various investments from pharmaceuticals and
gadgets to wellbeing guarantors and emergency
clinics and everyone has various elements
(Hammer J. 1997). The following are the
components that will have an impact over the
cost of capital in the healthcare services are,

5. MAIN DISCUSSION..
These are computed as a cost because they are
generally estimated will borrowing for the
investment in capital, Hammer J. (1997).
The interest expense
Dividend payment
Flotation cost
Opportunity cost
The net present value of the investment.

6. CONT…
• 4B)
• Data given:
• Given function: I= 500 – 1000 * cost of capital.
• % of cost of capital: 10%
• Equilibrium of health investment =?
• The actual cost of capital depending on the % = 1000*10/100
• =100
• Then from the function I = 500 – 100 = 400
• I=400.
• There for the equilibrium of health investment in term unit of
capital = 400
•
•

7. CONT…
• Then we asked to compute equilibrium total
investment expenditure?
• From the given function and %
• 1000 * 10% = 100.
• 100
• Therefore the total investment expenditure = 100
• This means that at the equilibrium, the health
investment should be 400 units of capital. It implies
that for each unit of capital invested, the return or
benefit is expected to be sufficient to offset the cost of
capital at a rate of 10% per year.

8. CONT…
• The equation suggests that the level of
investment in the health sector is inversely
related to the cost of capital. As the cost of
capital increases, the investment decreases. In
this scenario, a 10% cost of capital leads to an
equilibrium investment level of 400 units of
capital. This indicates that at this particular
cost of capital, the optimal health investment
lies at 400 units, World Health Organization,
(2001)

9. CONT…
• 4C)
• Data given:
• Given function: I= 500 – 1000 * cost of capital.
• % of cost of capital: 20%
• Equilibrium of health investment =?
• The actual cost of capital depending on the % =
1000*20/100
• =200
• Then from the function I = 500 – 200 = 300
• I=300.
• There for the equilibrium of health investment in term unit
of capital = 300

10. CONT…
• Then we asked to compute equilibrium total
investment expenditure?
• From the given function and 20%
• 1000 * 20% = 200.
100
• Therefore the total investment expenditure = 200
• Now, it is given that the cost of capital rises from 10 to
20 percent hence into an increase of percentage given,
therefore the equilibrium health investment is I = 300.

11. CONT…
• And, the total equilibrium expenditure is 20%
of the cost of capital; that is, 200
• This is because the equilibrium level of
expenditure rises when the percentage of the
cost of capital rises. This proves that an
increase in of percentage of cost of capital will
also make an increase in total investment
expenditure.