Question

The chapter argues that investment depends negatively on the interest rate because an increase in the cost of borrowing discourages investment. However, firms often finance their investment projects using their own funds.

If a firm is considering its own funds (rather than borrowing) to finance investment projects, will high interest rates discourage the firm from undertaking these projects? Explain.

Answer 1

Answer: Yes they will.

Step-by-step explanation:

With high interest rates, the company will be able to make better returns if they invested the money and took advantage of those interest rates instead of spending the money on their project.

Assets like bonds will be better to go into because they will offer a return based on the higher interest rates which will bring in good returns.

The company is free to use those funds to invest in projects if these projects will lead to a better return than could be gotten from holding bonds but if that is not the case, they should simply buy bonds and hold them for superior returns.