Suppose firms expect future output to be higher and future interest rates to be higher. Given...

Suppose firms expect future output to be higher and future interest rates to be higher. Given this information, how will firms alter investment in the current period? Explain.

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Expert Solution

Here interest rate means Return on capital employed.

If the firms expecting future output to be higher and future interest rates to be higher, then the firms has to alter financing method in current period in order to reduce Cost of capital, ie.

If the firm is raising funds from stock ie. From common stock and Preference Share,

Then they has to levere the firms ie. raising funds through debenture rather than common and preference stock.

Because Cost of Capital on Debenture is generally lower than the other method of raising funds.

If there would be lower cost capital, then Return on the Capital employed by firms will be higher. That will results in Higher earning per share and would leads Increase in price per share and will also enhance brand equity.

Rahul Sunny answered 1 year ago

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