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 reduce the availability of skilled labor needed for factory construction.
• C. Higher interest rates cause government regulations on factory construction to become stricter.
• D. Higher interest rates directly increase the price of raw materials required for production.

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. Analyze how an increase in borrowing costs affects the firm's decision by raising the overall cost of the investment project.
4. Consider that if the cost of financing the factory becomes too high, the expected returns from the investment may no longer justify the expense, leading the firm to delay or cancel the project.
5. Conclude that higher interest rates deter investment primarily because they increase the cost of borrowing, making new factory construction more expensive and less attractive.