Question

The Federal Reserve lowers interest rates in the economy to increase economic activity. Using the capital budget decision tools, discuss how decreasing interest rates can cause firms to make more investments. (Use references if possible)

Answer 1

Lowering of interest rate is considered to be a quantitative easing tool because when the interest rate is lowered, it will increase the money supply in the economy because the people will have to pay lesser on there loans and the bank would be having higher reserves because there is a a lower interest rate.

Lower interest rate is always an indicator of stimulation of demand into the overall economy and it will increase the demand so it will lead to increase in economic activity as increase in demand will increase the gross domestic product of the country.

When using the capital budgeting decision tools the interest rate change will lead to lower outflow of cash and it will help in discounting the project with the low cost of capital because it will help in saving more of the company's outflow of cash as there would be less interest payments.