How would a sudden increase in interest rates likely affect the component costs of capital

Expert Solution

A sudden increase in the interest rate will increase the costs of capital. cost of capital is the maximum rate of return that a firm gets when it invests so that the market value of the equity share of the company do not fall.

A rise in the interest rate will make it costlier for the firm to take debts because now more interest will have to be paid when the debt will be repaid. Thus an increase in interest rates will reduce the debt that is taken.

An increase in the interest rate also shows the opportunity cost of the return that could be earned with the money that was invested for the expansion of the company. The return that is given up is the opportunity cost that is lost by the company.

Thus a sudden increase in the interest rate will make debt (loan) taking difficult whereas increase the opportunity cost that is lost by financing the company which could otherwise be earned from otherwise.

Rahul Sunny answered 2 years ago

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