Therefore, cost of borrowing is fundamentally the nature of debt financing, which mostly hinges on prevailing interest rates. Normally, debt financing will occur when business generates capital though loans, bonds, and any other form of debt instrument which is repaid with an interest payment. The interest rate that a country’s central bank set up-for example, the Federal Reserve in the United States or the European Central Bank-decides the borrowing rate of the companies.
High Interest Rates:
High interest rates make the cost of borrowing very expensive. Companies have to pay high interest on loans and bonds. All these make their overall cost of capital go up. This may discourage firms from taking new debt since they will pay a high level of interest and lower profitability. For instance, a firm that seeks to expand by borrowing may delay its expansion plans in a high-interest rate environment as it cannot afford the cost.