Hi, what is cost of borrowing? If the interest rate on the borrowed amount is say, 6%, then what does 7% cost of borrowing mean? Same for cost of trade credit. CFAI text states : “…equivalent return to the customer of an alternative investment” + “If the customer’s cost of funds or short-term investment rate is less than the calculated rate (i.e. cost of trade credit - i am presuming) , the discount offers a better return”…return??? Please advice. By the way, I did find the formulae/calculations in Schewer Notes (This is reading 46) This may be very basic for some or am I losing it?
As far as the cost of debt goes, it is the market rate of the companies debt as opposed to the coupon rate they’re paying on it. The market rate represents what they would have to pay on new debt if they had to issue more today which is why it is different from the coupon rate.
What is the context in which it is being used? The companies cost of debt? If the company is borrowing at 6% and the market cost for a similar company(risk) is 7% then the company has a good deal. If it the market rate is 5%, then the company would want to call the bonds and reissue at a lower rate. I think it needs to be put in the perspective of who is borrowing and lending.
Thanks BizBanker and DTM86…these points are quite clear to me…I guess I just confused myself… My point is this: OK, a company borrows 10,000 loan (say line of credit)…and on that the company has to pay an interest of 6%…and on top of that a company has to pay a commission fee of say, 0.5%…then the total amount company has to pay would be the “cost of borrowing” (interest + commission fee) My question is, is that so??? …you will find this in CFAI Vol 4 - PAGE 124 (Working Capital Management)…Schweser notes doesnt have any of this or the calculations. I think this is different from what you guys are referring to…comments?
I would say in that context the cost of borrowing is 6.5%, but that is more like a short term borrowing rate that may or may not be included in their capital structure. My post earlier is more in the context of long-term debt (i.e., bonds) that would be part of the company’s capital structure and WACC