Discover how rising interest rates affect business values and the cost of capital
In this text, we will discuss the impact of interest rates on company valuation. To do so, it is important to understand what interest rates are, how they are currently in Brazil and around the world, and how they affect companies' cost of capital.
What are interest rates?
Interest rates are the cost of borrowing money, or the remuneration that a person or company pays when taking out a loan. They are determined by the central banks of each country, which use monetary policy to influence economic activity. When interest rates are high, the cost of borrowing is higher, which discourages consumption and investment. When interest rates are low, the cost of money is lower, which encourages economic activity.
Interest rates in Brazil
Currently, interest rates in Brazil are at levels historically high . This is due to the contractionary monetary policy adopted by the Central Bank.
Selic Rate: Brazil's base interest rate, the Selic, is currently at 10.50% per year . This rate is set by the Monetary Policy Committee (Copom) of the Central Bank of Brazil (BC) every six weeks, with the aim of controlling inflation.
Second highest real interest rate in the world: Compared to other countries, Brazil has the second highest real interest rate in the world , behind only Mexico. This real rate, which considers the Selic discounted from projected inflation, is 5.90% per year.
Cycle of cuts: Despite having the second highest real interest rate in the world, Brazil has been in a cycle of Selic rate cuts since August 2023. At the last Copom meeting, in May 2024, the rate was reduced by 0.50 percentage points, for the sixth consecutive time.
Outlook: Expectations for the future of interest rates in Brazil are mixed. Some analysts believe that Copom will continue to cut the Selic gradually, while others argue that the rate could be kept stable for a longer period.
Interest Rates in the World
Diverse scenario: Interest rates vary significantly between different countries in the world. Developed nations, such as the United States, have low interest rates, while developing countries, such as Argentina, have much higher rates.
US interest rate hike: In recent months, the US Federal Reserve (Fed) has been raising its benchmark interest rate to combat rising inflation. This move has had a knock-on effect, leading other countries to also raise their rates.
Global slowdown: Despite the upward trend in some countries, there are concerns that rising interest rates could slow the global economy. This is one of the main discussions among world leaders and economists at the moment.
Impact of interest rates on company valuation
Interest rates have a direct impact on the valuation of companies, as they affect the cost of capital, which is the rate of return required by investors to invest their money in a given company. When interest rates are high, a company's cost of capital is also high, as investors demand a higher return to compensate for the risk of the investment. This reduces the present value of the company's future cash flows, negatively affecting valuation.
Furthermore, rising interest rates can also lead to higher borrowing costs for companies, which reduces their ability to invest and grow. Companies that rely heavily on borrowing to finance their operations may struggle in a high interest rate environment.
In short, rising interest rates have a significant impact on the valuation of companies. Higher cost of capital and increased borrowing costs reduce the present value of a company’s future cash flows, negatively affecting its valuation. It is important for companies and investors to closely monitor changes in interest rates, as they can directly impact the value of businesses.
Cornerstone Partners helps entrepreneurs manage their businesses in a variety of market situations.
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