Question

How does capital budgeting decisions affect long-term borrowing rates for countries?

Answer 1

Capital budgeting is a process that helps to determine the organizations investments(long-term investments) in various projects over a long run.The long-term investment decisions are difficult because it extends several years beyond the current period. It's difficult to judge various factors over a long period of time,

The money spent in capital budgeting is can actually be worth more in the future because the organisation could have invested the money and received interest payments. Investments can be acquisation of a firm, building or investing in a particular sector. Investment in any project will have an impact on various factors. Some of them are listed below:

i) New job opportunity

ii) Economic growth of the country

iii) Increase in per capita income

These are the contribution made by the company while the selection of a new project.

Now there are various methods to calculate the cash flow of the project the organisation is going to invest in. These methods take into account the net present value , the future value , inflation rate of the country. An exact value can not be determined since it's a long term investment and a lot of factors may change over time. The implication is that the interest rate used to discount these cash flows should be based on the long-run view of real interest rates in the country rather than the real interest rates at the date of the forecast and the investment. An estimate of the interest rate to use to discount these cash flows based on projections of the interest rate their governments would pay if they borrowed in the foreign country, and a premium reflecting the difference between the interest rate they pay when at home over the interest rate the government pays.