Question

If the interest rate on a loan is higher than the expected return from an investment: a. the Federal Reserve will conduct expansionary monetary policy. b. a rational firm will not take out a loan for the investment. c. the Federal Reserve will conduct contractionary monetary policy. d. the government will conduct expansionary fiscal policy. e. a rational firm will take out a loan for the investment.

Answer 1

The correct answer is letter "B": a rational firm will not take out a loan for the investment.

Step-by-step explanation:

Rational individuals are those who make decisions based on benefit-cost analysis of the possible outcomes of investment. In such a case, if the interest rates of loans are higher than the expected return of an investment, it will be rational not to fund investment with money borrowed from a bank because loan payments will be higher than the revenue the investment can provide, which eventually represents more debt.

Answer 2

b. a rational firm will not take out a loan for the investment.

Step-by-step explanation:

For a company to continue to exist to perpetuity, the company must stay profitable.

A key consideration in the investment of funds into capital expenditure or other forms of investments is the rate of return. When this is compared with the cost of capital required to fund the investments (by debt or equity or by both debt and equity), it is only rational that the the rate of return be higher than the cost of capital.

The cost of capital in this case is the interest rate on the loan (a form of debt financing).