Which combination tends to stimulate investment?

• A. Higher expected returns and lower interest rates
• B. Lower expected returns and higher interest rates
• C. Higher taxes on profits
• D. Decreased availability of credit

Answer: (A)

Investment is driven when the projects look highly profitable and the cost of funding is low. If a project is expected to generate strong returns, its cash inflows are valuable, boosting its net present value. Simultaneously, lower interest rates reduce borrowing costs and lower the discount rate used in appraisal, further increasing the present value of future cash flows. This combination makes more projects financially attractive and encourages firms to invest.

In contrast, lower expected returns reduce project profitability, higher interest rates raise the cost of financing and the hurdle rate, and either higher taxes or tighter credit conditions dampen after-tax cash flows and access to funds, all of which make investment less appealing.