Final answer:
The firm should consider the investment's 6% return rate against possible alternatives, opportunity costs, inflation, and risk. If interest rates increase, the present value of future payments from an investment like a bond would decrease.
Step-by-step explanation:
To decide whether the firm should go ahead with the investment earning a 6% rate of return, we need to consider the opportunity cost of capital. If the firm has to borrow the money, the interest expense would be 8%, which is higher than the return on the investment. Since the firm has the cash and will not need to borrow, it avoids this 8% cost. However, this does not mean the investment is automatically a good decision. The firm must consider if there are better alternatives that exceed the 6% return rate, the cost of lost opportunities, inflation, and whether the return compensates adequately for the risk involved.
For example, assume a simple two-year bond issued for $3,000 at an interest rate of 8%, paying $240 annually. Using the present value formula, if the discount rate is the same as the interest rate, 8%, the present value of the bond does not change. If the discount rate increases to 11%, the present value of those payments decreases. This is because the dollars received in the future are worth less today if discounted at the higher rate, meaning that an investor would pay less for this bond if interest rates increase.