Answer the Question on the Basis of the Following Information

question 127

Multiple Choice

Answer the question on the basis of the following information.Assume that if the interest rate that businesses must pay to borrow funds were 20 percent, it would be unprofitable for businesses to invest in new machinery and equipment, so investment would be zero.But if the interest rate were 16 percent, businesses would find it profitable to invest $10 billion.If the interest rate were 12 percent, $20 billion would be invested.Assume that total investment continues to increase by $10 billion for each
Successive 4 percentage point decline in the interest rate.Refer to the information.Which of the following is an accurate verbal statement of the described relationship?

• A)There is no regular or dependable relationship between business investment and the interest rate.
• B)The amount of business investment is unaffected by changes in the interest rate.
• C)Investment spending by businesses varies inversely with the interest rate.
• D)Investment spending by businesses varies directly with the interest rate.

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Definitions:

M&M Proposition II

A firm’s cost of equity capital is a positive linear function of its capital structure.

Cost of Capital

The cost of funds used for financing a business, typically considered as the weighted average of the costs of equity and debt financing.

Tax Rate

The amount of tax a person or company must pay, expressed as a percentage of income.