Peru\'s annual inflation rate for 1990 was 7,650 percent, an all time high for t

Question

Peru's annual inflation rate for 1990 was 7,650 percent, an all time high for this country. In 1991, the annual rate dropped backed to approximately 140 percent. In September 1993, the annual rate was at approximately 20 percent, the lowest in 17 years. Given the higher rate in 1990, is it possible to make a long-term capital investment in this environment? Given the scenario above, if you were to make a capital investment, what are the characteristics that would be most important to you? Address financing, pricing, cost of inputs, and any other factors.

Explanation / Answer

Answer:

Capital investment is long term investment which requires long term funds in huge numbers. For this purpose company has to take loans or issue debt so that it can meet its long term needs.

Now Peru in 1990 had 7650 percent inflation. Inflation influences the cost of borrowing as it makes everything costlier in the market and interest rate too goes up in that situation.

Increase in rate of interest lowers the sentiments of the shareholders to make capital investments as their cost of borrowing becomes unmanageable.

So at this rate of inflation it is impossible for the company to make capital investment.

If I would have to make the capital investment like this the most important factor to consider would be the return on equity of that investment. ROE gets a boost when the cost of inputs, financing etc are favorable. If there are in the grey then its better to wait for some more time to get positive vibes in the investment climate and then at the right moment invest your money.

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