Final answer:
The statement the student asked about is true. Avoidable interest is the lesser of the actual interest cost incurred or the interest cost that could be theoretically avoided if no expenditures were made for the asset. This concept is central to understanding the impact of interest rates on investment spending by a firm.
Step-by-step explanation:
The statement provided in the student's question is true. Avoidable interest is calculated as the lesser amount between the actual interest cost that a company incurs during a fiscal period and the theoretical interest cost that could be avoided if no expenditures were made for the construction of an asset. This concept acknowledges that when a firm finances the construction of an asset, such as big-ticket items, there is a cost of investment that includes not just the expense of the asset itself but also the interest on the borrowed funds, which represents the opportunity cost of investing capital.
If a firm finances the construction at a 9% interest rate but could achieve a 5% social return, its effective rate of interest for decision-making would be 4%. This reduction in effective interest cost could lead to higher investment spending, as lower interest rates tend to stimulate such expenditures. However, a financial investor must also consider risk premiums above the available rates for riskier investments. For example, a 15% interest rate might be applied to future payments for a high-risk investment, reflecting the higher cost of capital due to the increased risk.