Question

How does an increase in interest rates generally impact overall business? Why is this important when attempting to understand leverage?

Answer 1

Interest rate is the amount company needs to pay when funds are borrowed that is when debt is raised. Leverage is in relation to the amount of funds borrowed by the company by way of liabilities. Interest is an expense for the company and so if interest rate increases the interest expense would also increase with increase in leverage and so this would reduce the net income of the business. The increase in interest rates would lead to lessor debt taken by the company to fund its business which would impact the business operations. The interest rate is important while undertaking the leverage for the firm as it would impact the current and future profits and the funds available for future expansion. If there is continuous increase in interest rates company may face financial losses and so company will have to effectively manage its required capital when interest rate increases.