Risky investments

Insurance and Ri In the venture-premium method of assessment, risky investments are required to yield a rate of return that adds a premium to the cost of finance. D. F. Rudd and C. C. Watson (The Strategy of Process Engineering, Wiley, New York, 1968, p. 91) consider this relationship ... 

When gasoline-powered automobiles are modified to burn a fuel such as ethanol alone, they are known as dedicated ethanol vehicles—risky investments for buyers who have concerns about future availability. For example, Brazil s Proalcool program promoted and heavily subsidized ethanol, and thus dedicated ethanol vehicles, from 1975 to 1988. Once the subsidies were curtailed and then eliminated (estimates of the costs of the subsidy to the government range from 7 to 10 billion), shortages resulted. Many of the owners of ethanol-dedicated vehicles either had to junk or retrofit the vehicles to run on gasoline, and the sales of ethanol-dedicated vehicles went from 50 percent of the market in 1988 to 4 percent by mid-1990. 

What are your financial circumstances If you have ample savings to cover your needs, you may be able to take additional risk and not substantially affect your financial status. However, if you have limited resources, it might be better to concentrate on less risky investments in order to preserve what you have. 

However, nothing would induce one to make a new plant investment of a similar nature again unless there were a sufficiently large positive profit. Projected return on investment (ROI) is one of the most important determinants of new plant investment. A firm must make sufficient ROI to justify plant expansion, and a firm with a risky investment would require even higher projected ROI to proceed with a new plant. 

The industry s collective response to charges that drug prices are too high or are increasing too fast has been to point to the high and increasing cost of pharmaceutical R D and their need to repay investors for their substantial and risky investments (325,326,505). Industry representatives have pointed to academic studies of the... 

OTA s report focuses mainly on the economic side of the R D process. Pharmaceutical R D is an investment, and the principal characteristic of an investment is that money is spent today in the hopes of generating even more money in the future. Pharmaceutical R D is a risky investment therefore, high financial returns are necessary to induce companies to invest in researching new chemical entities. Changes in Federal policy that affect the cost, uncertainty and returns of pharmaceutical R D may have dramatic effects on the investment patterns of the industry. Given this sensitivity to policy changes, careful consideration of the effects on R D is needed. 

Lintner J. 1969. The valuation of risk assets and the selection of risky investments in stock portfolios and capital budgets. Rev. Econ. Stat., 51(2), 222-224. 

Some analysts advocate adjusting the minimum attractive rate of return to compensate for risky investments, suggesting that, since the future is uncertain, stipulation of a minimum attractive rate of return of, say, i + Ai wUl ensure that i wUl be earned in the long run. Since some investments will not turn out as well as expected, they wUl be compensated for by the incremental safety margin, A . This approach, however, fails to come to grips with the risk or uncertainty associated with estimates for specific alternatives, and thus an element Ai in the minimum attractive rate of return penalizes all alternatives equally. 

Perrakis, S., and Henin, C., The Evaluation of Risky Investments with Random Timing of Cash Returns, Management Science, Vol. 21, No. 1, 1974, pp. 79-86. 

Lintner, J., 1965. The Valuation of Risk and the Selectionof Risky Investments in Stock Portfolios and Capital Budgets. Rev. Econ. Stat. 47 (1), 13-37. 

The example in the preceding section showed that shareholders earn the residual income after satisfying the fixed claims of the bondholders. Creditors only want to cover their interest claims and avoid risky investments. From the shareholders perspective, risky investments promising high returns conform with their interests, because shareholders and not bondholders decide on further employment of management. Thus management will decide in favor of shareholders. Bondholders bear a similar risk but are excluded from participation in the growth of the company s value. 

The business environment, in which the healthcare network operates, can be described in terms of the knowledge-intensiveness that makes healthcare supply driven, payer s inability to control outcomes, risky investment in new drugs and treatments, defensive practice of medicine, paucity of investment in preventive healthcare, industry-fragmentation, and market imperfections. 

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