Why might higher interest rates deter a firm from building a new factory?

• A. Higher interest rates increase the cost of borrowing, making investment in new factories more expensive.
• B. Higher interest rates directly increase the price of raw materials required for production.
• C. Higher interest rates cause government regulations on factory construction to become stricter.
• D. Higher interest rates reduce the availability of skilled labor needed for factory construction.

Answer: (A)

Verified step by step guidance

1. Understand that when a firm considers building a new factory, it often needs to borrow money to finance the investment.
2. Recognize that the interest rate represents the cost of borrowing money; higher interest rates mean the firm must pay more in interest over time.
3. Realize that an increase in borrowing costs raises the overall cost of the investment project, making it less attractive or profitable.
4. Consider that if the expected returns from the new factory do not sufficiently exceed the higher borrowing costs, the firm may decide to delay or cancel the investment.
5. Note that higher interest rates do not directly affect the price of raw materials, government regulations, or labor availability in this context, so these factors are less relevant to the firm's decision.