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ACCA Strategic Professional · Advanced Financial Management · The role and responsibility of senior financial executive/advisor

A government adopts an expansionary fiscal policy by cutting corporate tax rates and increasing public infrastructure spending, financed by borrowing. Which is the most likely implication for a manufacturer in that country?

Lower corporate tax and higher public spending improve after-tax cash flows and demand for the manufacturer. However, financing the deficit by borrowing can push interest rates up, raising the cost of capital, so the effect is mixed rather than uniformly positive.

  1. APost-tax project cash flows improve, but higher government borrowing may put upward pressure on interest ratesCorrect
  2. BPre-tax cash flows fall because corporate tax cuts reduce demand
  3. CInflation is certain to fall because spending rises
  4. DThe exchange rate must be fixed by the central bank

Explanation

Lower tax rates raise after-tax cash flows and infrastructure spending can stimulate demand. Government borrowing can crowd out private borrowing and raise interest rates. The other options are not implied by the policy.

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