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Firms' Investment Decisions and Interest Rates

Author

Listed:
  • Tom Rosewall

    (Reserve Bank of Australia)

  • Kevin Lane

    (Reserve Bank of Australia)

Abstract

Firms typically evaluate investment opportunities by calculating expected rates of return and the payback period (the time taken to recoup the capital outlay). Liaison and survey evidence indicate that Australian firms tend to require expected returns on capital expenditure to exceed high ‘hurdle rates’ of return that are often well above the cost of capital and do not change very often. In addition, many firms require the investment outlay to be recouped within a few years, requiring even greater implied rates of return. As a consequence, the capital expenditure decisions of many Australian firms are not directly sensitive to changes in interest rates. Furthermore, although both the hurdle rate of return and the payback period offer an objective decision rule on which to base expenditure decisions, the overall decision process is often highly subjective, so that ‘animal spirits’ can play a significant role.

Suggested Citation

  • Tom Rosewall & Kevin Lane, 2015. "Firms' Investment Decisions and Interest Rates," RBA Bulletin (Print copy discontinued), Reserve Bank of Australia, pages 01-08, June.
    • Handle: RePEc:rba:rbabul:jun2015-01
    as

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    File URL: https://www.rba.gov.au/publications/bulletin/2015/jun/pdf/bu-0615-1.pdf
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    References listed on IDEAS

    as
    1. Tor Brunzell & Eva Liljeblom & Mika Vaihekoski, 2013. "Determinants of capital budgeting methods and hurdle rates in Nordic firms," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 53(1), pages 85-110, March.
    2. Ravi Jagannathan & Iwan Meier & Vefa Tarhan, 2011. "The Cross-Section of Hurdle Rates for Capital Budgeting: An Empirical Analysis of Survey Data," NBER Working Papers 16770, National Bureau of Economic Research, Inc.
    3. Besomi, Daniele, 1998. "Roy Harrod and the Oxford Economists' Research Group's Inquiry on Prices and Interest, 1936-39," Oxford Economic Papers, Oxford University Press, vol. 50(4), pages 534-562, October.
    4. Graham, John R. & Harvey, Campbell R., 2001. "The theory and practice of corporate finance: evidence from the field," Journal of Financial Economics, Elsevier, vol. 60(2-3), pages 187-243, May.
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    2. Hwang, In Do & Lustenberger, Thomas & Rossi, Enzo, 2021. "Does communication influence executives’ opinion of central bank policy?☆," Journal of International Money and Finance, Elsevier, vol. 115(C).

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