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Corporate Finance
Potential Impacts of an Increasing Interest Rates There is a general relationship between supply and demand. As prices for goods decrease the demand usually increases (Nellis and Parker, 2006). The converse is also true; when prices increase the demand will usually decrease
Interest rates have a strong influence in the economy. This influence is one reason many central banks utilize interest rates as a monetary tool in an effort to control the supply of money. Since December 2008 the U.S. has seen some of the lowest central bank interest rates, with the Federal Reserve holding down rates in order to help stimulate economic growth. The Federal Reserve may have recently forecast interest rates remaining close to zero until some point in 2013, but at some point they will have to increase (Anonymous, 2011). When the interest rate rise does occur it will impact on a number of areas of the economy; this paper will consider some of those impacts.
Impact on the Financing of Big Ticket Items
Big ticket items are expensive goods which will often require the purchaser to obtain some type of credit agreement. If the interest rates increase this is likely to have a negative impact on demand for those goods, as they will become more expensive to purchase. This can be seen by looking at a simple example; a consumer is considering buying a car for $10,000 which they will finance with a 5-year loan. The impact of increasing interest rates may be seen by looking at the table below.
Table 1; $10,000 loan over 5 years at differing interest rates
Loan at 5%
Loan at 7%
Loan at 9%
Monthly repayment
(Nellis and Parker, 2006). If the purchaser is using financing the amount of the monthly loan repayment will be seen as part of the price. As seen above, if the car loan repayment increases from $188.61 to $207.58 per month this is effectively an increase of $18.97 in the monthly cost of the purchase. Where it becomes more expensive the demand for big ticket items from buyers using loans is likely to fall. They may choose alternatives such as prolonging the life of existing big ticket items, repairing rather than replacing mechanical items or extending or improving a home rather than moving (Nellis and Parker, 2006). If purchases are still made the demand may shift to the lower priced end of the market. Therefore, the total value of the market for big ticket items is likely to decrease.
Present and Future Values of Annuities
An annuity is the purchase of a regular income with a…
The calculation of the present value of an annuity is complex, as this involves discounting the future cash flows into today's value. If interest rates increase the cash flow from the annuity increases (increasing the future value). The present value will depend on inflation, inflation may increase, but if the economy is managed correctly inflation should be held at a rate lower than the proportional increase in interest rates. Theoretically, the present value may also increase, but this will be less pronounced compared to the future value and is dependant on many divergent factors, apart from inflation which may include diverse issues which are not directly related to interest rates, such as the cost of labor and the cost of oil.
Impact on NPV Calculations
Net present value calculations look at the value of an investment in the future by taking the futures cash flows and discounting them into today's value by allowing for the time value of money. The discount rate may be based on the expected rate of inflation; however firms will often base the discount rate on their actual cost of capital (Drake and Fabozzi, 2009). As interest rates increase the cost of capital (which is discussed in the next section) will also increase. Assuming the same cash flows the following tables demonstrate the difference that that an increase in interest rates will have on the NPV. The example of a five-year investment of $10,000 creating an annual return of $3,500 may be used. In table 2 the discount rate
Corporate Finance Tools in Daily Life Many of the concepts associated with corporate finance also have applications in everyday life. A range of corporate finance tools are already used in everyday life, often without realization as corporate finance tools are often an extension of common financial practices. More complex corporate finance tools may also provide a great deal of potential to enhance daily life financial management. By looking at task associated
28% This gives project B. An IRR of -0.028% Part C Using the above assessments each may indicate which investment may be preferred. Using the payback period project a has a payback period of 4 years, whereas project B. has a payback period of 3 years 8 months. If the fastest payback period is preferred than project B. will be chosen. The NPV which discounts the net revenues into a net present value shows
The curve describing this relationship between risk and return is a hyperbole connecting one and the other. Logically and economically, this also makes sense: if the investor is willing to assume more risks, he is also likely to potentially discover more alternatives and solutions in which to invest his money and open his investment to a greater impact from the market, in a positive sense. Additionally, spending more money on
This is a particularly useful metric for retailers, because the fixed assets are typically the stores and land. The greater the degree to which the retailer can convert the stores and land to sales, the implication is that the retailer is a superior merchandiser. For Wal-Mart, the sales/net fixed assets ratio is 3.25. The RMA for this metric holds that 7.3 is "worst." This indicates that Wal-Mart is doing
Guillermo Corporate Finance Examining Guillermo Furniture: The Principles of Corporate Finance Guillermo Furniture, a furniture manufacturer, wholesaler, and retailer located in Sonora, Mexico is faced with a choice. The company is facing increasing competition from overseas competitors that employ newer technologies in the manufacturing process that allow them to reduce labor costs without significantly sacrificing the quality of their products. With a rather substantial initial investment, Guillermo Furniture can purchase the equipment
It is also interesting to comment on the article's evaluation of the potential future trends for the companies in developing countries. The article evaluates a closer integration of these companies in the global market. This is something that is potentially bound to happen. Indeed, these companies are already playing a more important role on a regional level by investing in neighbor economies. Recently, a Kazakh corporation purchased a Romanian fuel