Interest rates have risen Where does the increase in interes

Interest rates have risen. Where does the increase in interest rates show up in capital budgeting problems?

Solution

Capital budgeting is basically a process wherein the management of a company take informed decisions about long-term investment of a company\'s capital. Spending the money in R&D, buying a new machinary, opening a new plant etc all are part of capital budgeting.

Management and businesses thorougly study these investments, their future effects, time involved, rate of interest, opportunity cost etc.

Interest rates play improtant part in this study because businesse look the Present value of the investment which they are going to make and this present value is calculated by discounting the future cash flow generated by the investment. To discount these cash flows, we need interest rates.

In short, higher the rates, lower the NPV (may be negetive also), lower the chances of the investment to get approved.