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Application report 2 - Essay Example

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The rise in interest rate will increase the cost of capital and it will have the impact on consumer financing.
Assuming currently a vehicle…
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Application report 2
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Download file to see previous pages The rise in federal interest rate causes general increase in the cost of capital. This leads to the increase in the cost of manufacturing and services. The present value of annuity such as pension will decrease because the value of dollar or purchasing power of dollar will fall.
However, with the rise in interest cost the higher interest rate of 6% will reduce the present value of annuity to 40,000/1.06= $37,735. The person has lost $360 due to rise in the cost of living. Vice versa is also true. Further, the future value of the money invested will rise along with the rise in interest cost.
The significance of above calculation is that total annuity though received is $5000 yet actual worth is $4329 only. The worth will further be reduced if interest rate is still high, say, 7 %. The quick calculation can be done with the same equation.
Firms calculate weighted average cost of capital that depends upon the cost of equity and the cost of debt. The cost of debt will rise with the rise in interest cost as company will need to give higher interest on its borrowings. The increase in the cost of debt will also increase the cost of equity because the cost of equity rules a few percentage points higher (usually 5 to 10% depending upon the risk profile of the company) than the debt cost.
The higher interest cost will result into higher production cost of the product or services. If the company is unable to pass the increased cost to the consumers then it will reflect into the reduced earnings of the company for a given year. The net profit of the company is calculated by deducting the interest paid on the debt in a given year; however lesser earnings in a given year may also result into lesser dividend for ...Download file to see next pagesRead More
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