Final answer:
When the interest rate for calculation increases from 6% to 10%, the benefit-cost ratio of the project will generally decrease as future benefits are discounted more heavily. This is comparable to bond market dynamics where existing bonds lose value as market interest rates rise.
Step-by-step explanation:
The benefit-cost ratio of a project is likely to change when the interest rate used for calculations increases. Initially calculated at a 1.7 ratio using a 6 percent interest rate, if a 10 percent interest rate is applied instead, the benefit-cost ratio will generally decrease. This is because the present value of future benefits is discounted at a higher rate, making them less valuable compared to the costs today.
An analogy can be seen in the bond market scenario. If a bond was issued at a 6% interest rate and market rates increase to 9%, the price of the existing bond would decrease so that its yield to maturity aligns with the new, higher market rates. This is similar to how increasing the discount rate in project evaluation decreases the present value of the project's future benefits.
When considering an investment opportunity, it's crucial to compare the expected rate of return to the cost of capital. For instance, if a firm can earn a 6% return on an investment, but would have to pay 8% interest on a loan to finance it, the firm should not invest if they need to borrow the money. However, if they have cash on hand, they may decide to proceed as they are not incurring the higher loan cost.