Question

1. Assess the implications of a fall in borrowing rates for a company that is funded by both equity and debt.

kindly note that i need full answer with full deatils

Answer 1

Lets assume for simplicity that the company has equal debt and equity(1:1)

Now by decreasing borrowing rates means that the debt is available cheaply to the company.

1. The debt available is cheaper thus overall WACC decreases.

2. The interest payments decreases thus the expenses reduce and profit rises but the tax benifit of the debt also diminishes

3. Once the borrowing rates decreases but the cost of equity is higher thus the company still have high cost of equity.

4. The decreasing borrowing rate also means that the company earn more on capital invested

5. The interest coverage ratio of the company improves

6. If the company is in business of lending then the Net interest margin increases (if the lending rate is constant)

7. Company take upon more debt too if the debt to equity permits as the company would be able to pay same amount of interest with higher debt