A fall in the market interest rate makes any investment project: a) more profitable whether the funds were borrowed or came from retained earnings. b) more profitable only if the funds were borrowed. c) less profitable if the funds were borrowed and more profitable if it came from retained earnings. d) less profitable whether the funds were borrowed or came from retained earnings.

Question

Elaine Cordova

Business

2 February, 04:40

A fall in the market interest rate makes any investment project: a) more profitable whether the funds were borrowed or came from retained earnings. b) more profitable only if the funds were borrowed. c) less profitable if the funds were borrowed and more profitable if it came from retained earnings. d) less profitable whether the funds were borrowed or came from retained earnings.

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Answers (1)

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Conner Hanson · Answer 1

a) more profitable whether the funds were borrowed or came from retained earnings.

Explanation:

Interest rates are an expense to the projects. The higher the interest rates, the higher the monthly interest repayments. Interests are current expenditures occurring every month; their effects are to lower the monthly income generated by the projects.

If interest rates fall, it means monthly interest repayments will reduce, thereby lowering expenses leading to higher profits. Retained earnings are shareholder funds that the company did not pay out as dividends. The cost of retained earnings should be equal to the value the shareholders will get if they invest the funds elsewhere.

Retained earning is an opportunity cost because shareholder chooses to invest in the project as opposed to elsewhere. If interest rates fall, the cost of retained earnings will fall as alternative investments would also yield less. This will increase the profitability of the project.