Week 5 Initial Post (TLR)
Capital budgeting tools are useful in the evaluation of poetical investment before a company I able to commit their money to any project. The capital budgeting decision tools are vital in assessing the lifetime of a project while generating income. The federal reserve lowers the interest increases economic activities in the economy. The lower the interest rate or the cost of capital, the more chances that the internal rate of return of capital will be higher, which increases the investment in the economy. Companies invest in a project while it meets the benchmark of the internal rate of return. Therefore, a low-interest rate means that many projects will meet the benchmark of IRR. For example, if the interest rate is at 12% and the IRR for a project is 11%, such a project cannot be undertaken because it will cost more to invest than the returns. If the interest rate is lowered to 5%, the project can be undertaken because, at 11% IRR, the returns are more.
Additionally, low-interest rates are also useful in informing the decision for companies to invest. For example, while using the accounting rate of return as a decision tool, companies would invest more since the cost of capital is low, and hence increasing the accounting rate of return will higher, which is desirable for investors. It helps an investor to know how profitable a project is. For example, when the rate of interest is high, maybe 15% of the profit will be low than when the interest rate is at 5% for the same project, which gives a higher accounting rate of return. Therefore, lower interest rates spur economic activities due to the increase in ARR. Even though the interest rate is not considering while calculating the payback period of a project, higher interest rates would mean that the initial cost of the project will be higher than when the interest rate is low. When the inters t rate is higher, it means that more time will be taken to recover the initial investment, which is undesirable for investors. Therefore, lower interest rates will lower the cost of capital of starting projects, which reduces the time taken to recover the money invested.