Question

What effect would inflation have on a company’s cost of capital? (Hint: Think about how inflation influences interest rates, stock prices, corporate profits, and growth.)

Short answer

It can only have a adversely affect on a company's cost of capital, constraining it to go up.This is accurate because inflation results in increased interest rates and lower share prices, so raising the cost of debt and equity directly and the cost of preferred stock indirectly.

Step-by-step solution

Introduction to inflation

Inflation is the rate at which the worth of any currency falls against the other international currencies and, thus, the level of prices in the wholesale and retail market for goods and services rises.Inflation aims to measure the general effect of price changes for a differentiated arrangement of products and services.

Effect of inflation on a company’s cost of capital 

Inflation generally means an increase in the prices and when it comes to the cost of capital, inflation always hits it up negatively.An increased rate of inflation would result to increase cost of capital, while cost of capital would be decreased at high rates of inflation by additional increases.