INVESTMENT OPPORTUNITY PRINCIPLES

And we decide whether or not this investment opportun-ity is worth while by weighing the costs against the re-turns in terms of present worth, as reckoned by the rateof interest.

§3. The Concept of Rate of Return Over Cost

When we compare two optional income streams, andeither may be preferable to the other according as onerate of interest or another obtains, the two options wouldstand on a par if the right intermediate rate were usedfor calculating the present values of the two options. Thatis, this equalizing rate is such that the present values ofthe two options would be equal, or what amounts to thesame thing, it is such that, if that rate is used for dis-counting, the present value of the cost of choosing oneoption instead of the other would be equal to the presentvalue of the return.

This hypothetical rate of interest which if used incalculating the present worth of the two options com-pared would equalize them or their differences (cost andreturn) may be called the rate of return over cost andhereafter this name will generally be employed. This newmagnitude (or factor) in our study plays the central roleon the investment opportunity side of interest theory.

Let us now apply this rate of return over cost to thecase of the options already used for illustration.

We have seen that, in our land example, if the rate ofinterest is 4 per cent, the net advantage is in favor of theforestry use, and if the rate of interest is 4% per cent,the net advantage is in favor of the farming use. It is evi-dent then that at some intermediate rate of interest thecomparative advantages of the two uses would be exactlyequal. This intermediate rate is approximately 4.2 per

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