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

• A. Higher interest rates cause the price of raw materials to decrease.
• B. Higher interest rates reduce consumer demand for the firm's products directly.
• C. Higher interest rates lead to lower wages for factory workers.
• D. Higher interest rates increase the cost of borrowing, making investment projects less profitable.

Answer: (D)

Verified step by step guidance

1. Understand the role of interest rates in investment decisions: Interest rates represent the cost of borrowing money. When a firm wants to build a new factory, it often needs to borrow funds to finance the construction and equipment.
2. Recognize that higher interest rates increase the cost of borrowing: If interest rates rise, the firm must pay more in interest expenses on any loans it takes out, which raises the overall cost of the investment project.
3. Analyze how increased borrowing costs affect profitability: Higher costs reduce the expected return on the investment, making the project less attractive compared to other uses of the firm's funds or waiting for better conditions.
4. Consider the impact on the firm's decision-making: Because the project becomes less profitable, the firm may decide to delay or cancel building the new factory to avoid higher financing costs.
5. Note why other options are less relevant: Higher interest rates do not directly cause raw material prices to decrease, reduce consumer demand directly, or lead to lower wages; the primary effect is through increased borrowing costs affecting investment profitability.