Example: Larry’s Lithium deals with a rise in interest rates
Let's use an example of Larry’s Lithium, a U.S.-based raw lithium refining company, that secured an original loan of $5 million at a 5% interest rate, resulting in an annual interest expense of $250,000. This interest rate was not fixed and instead floated with the Federal Reserve’s base rate. After the Federal Reserve increased interest rates, the loan’s interest rate climbed to 7.5%, pushing the company’s annual interest expense to $375,000.
This 50% rise in interest expense directly affects Larry's Lithium's bottom line, reducing available cash for expansion, equipment upgrades, and other operational improvements that might be sorely needed in the future.
Businesses relying on debt must carefully manage rising borrowing costs to avoid financial strain when interest rates fluctuate and interest expense becomes a much greater liability than may have previously been believed.