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The Incompatibility of the Average Investment Method for Calculating Interest Costs with the Principle of Alternative Opportunities

Published online by Cambridge University Press:  28 April 2015

Arthur J. Walrath
Arthur J. Walrath*
Affiliation:
Economic Development Division, Rural Development Service, stationed at Blacksburg, Virginia
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Extract

“The rate of interest charged should be … the amount the money could earn in an alternative investment. Interest is commonly charged at 6 percent on the average value of the machinery. …” This is a quotation taken from a bulletin published in 1965. Similar statements can be found in many publications. That bulletin has recently been revised. In the revision, the first part of that statement is still recognized, but the average investment method is not used to calculate interest costs.

In the first sentence, the principle of alternative opportunities is accepted, i.e., the minimum acceptable rate of return is that which the investor can obtain in an alternative investment that he would be willing to make. In general, economists agree that this is the rate that should be used in analyzing investment opportunities.

Type
Research Article
Information
Journal of Agricultural and Applied Economics , Volume 5 , Issue 1 , July 1973 , pp. 181 - 185
Copyright
Copyright © Southern Agricultural Economics Association 1973

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