THIRD APPROXIMATION

THE TWO PRINCIPLES AS TO INVESTMENTOPPORTUNITY

A. Empirical Principle

The condition that each individual has a given rangeof choice still holds true, but these choices are no longerconfined to absolutely certain optional income streams,but now include options with risk. That is to say, eachindividual finds open to his choice a given set of options(and opportunities to shift options, that is, opportunitiesto invest) which options differ in size, time shape, com-position and risk.

B. Principle of Maximum Present Value

When risk was left out of account, it was stated thatfrom among a number of different options the individualwould select that one which has the maximum presentvalue—in other words, that one which, compared withits nearest neighbors, possesses a rate of return over costequal to the rate of time preference, and therefore tothe rate of interest.

When the risk element is introduced, it may still besaid that the maximum present value is selected, but intranslating future uncertain income into present cashvalue, use must now be made of the probability andcaution factors.

But when we try to express this principle of maximumpresent value in its alternative form in terms of the mar-ginal rate of return over cost, we must qualify this expres-sion to: the marginal rate of anticipated return over cost.

Three consequences follow. First, that the rate ofreturn over cost which will actually be realized may turnout to be widely different from that originally anticipated.

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