Financial Terms Cost of funds

# Definition of Cost of funds

## Cost of funds

Interest rate associated with borrowing money.

# Related Terms:

## Interest

The cost of funds loaned to an entity. It can also refer to the equity ownership
of an investor in a business entity.

## Accelerated cost recovery system (ACRS)

Schedule of depreciation rates allowed for tax purposes.

## Agency cost view

The argument that specifies that the various agency costs create a complex environment in
which total agency costs are at a minimum with some, but less than 100%, debt financing.

## Agency costs

The incremental costs of having an agent make decisions for a principal.

## All-in cost

Total costs, explicit and implicit.

## Average cost of capital

A firm's required payout to the bondholders and to the stockholders expressed as a
percentage of capital contributed to the firm. Average cost of capital is computed by dividing the total
required cost of capital by the total amount of contributed capital.

## Bankruptcy cost view

The argument that expected indirect and direct bankruptcy costs offset the other
benefits from leverage so that the optimal amount of leverage is less than 100% debt finaning.

## Beta (Mutual Funds)

The measure of a fund's or stocks risk in relation to the market. A beta of 0.7 means
the fund's total return is likely to move up or down 70% of the market change; 1.3 means total return is likely
to move up or down 30% more than the market. Beta is referred to as an index of the systematic risk due to
general market conditions that cannot be diversified away.

## Beta equation (Mutual Funds)

The beta of a fund is determined as follows:
[(n) (sum of (xy)) ]-[ (sum of x) (sum of y)]
[(n) (sum of (xx)) ]-[ (sum of x) (sum of x)]
where: n = # of observations (36 months)
x = rate of return for the S&P 500 Index
y = rate of return for the fund

## Carring costs

costs that increase with increases in the level of investment in current assets.

## Cost company arrangement

Arrangement whereby the shareholders of a project receive output free of
charge but agree to pay all operating and financing charges of the project.

## Cost of capital

The required return for a capital budgeting project.

## Cost of carry

Related: Net financing cost

## Cost of lease financing

A lease's internal rate of return.

## Cost of limited partner capital

The discount rate that equates the after-tax inflows with outflows for capital
raised from limited partners.

## Cost-benefit ratio

The net present value of an investment divided by the investment's initial cost. Also called
the profitability index.

## Dividend yield (Funds)

Indicated yield represents return on a share of a mutual fund held over the past 12
months. Assumes fund was purchased 1 year ago. Reflects effect of sales charges (at current rates), but not
redemption charges.

## Endowment funds

Investment funds established for the support of institutions such as colleges, private
schools, museums, hospitals, and foundations. The investment income may be used for the operation of the
institution and for capital expenditures.

## Equivalent annual cost

The equivalent cost per year of owning an asset over its entire life.

## Execution costs

The difference between the execution price of a security and the price that would have
existed in the absence of a trade, which can be further divided into market impact costs and market timing
costs.

## Federal funds

Non-interest bearing deposits held in reserve for depository institutions at their district Federal
Reserve Bank. Also, excess reserves lent by banks to each other.

## Federal funds market

The market where banks can borrow or lend reserves, allowing banks temporarily
short of their required reserves to borrow reserves from banks that have excess reserves.

## Federal funds rate

This is the interest rate that banks with excess reserves at a Federal Reserve district bank
charge other banks that need overnight loans. The Fed funds rate, as it is called, often points to the direction
of U.S. interest rates.

## Financial distress costs

Legal and administrative costs of liquidation or reorganization. Also includes
implied costs associated with impaired ability to do business (indirect costs).

## Fixed cost

A cost that is fixed in total for a given period of time and for given production levels.

## Forward Fed funds

Fed funds traded for future delivery.

## Friction costs

costs, both implied and direct, associated with a transaction. Such costs include time, effort,
money, and associated tax effects of gathering information and making a transaction.

## Funds From Operations (FFO)

Used by real estate and other investment trusts to define the cash flow from
trust operations. It is earnings with depreciation and amortization added back. A similar term increasingly
used is funds Available for Distribution (FAD), which is FFO less capital investments in trust property and
the amortization of mortgages.

## Incremental costs and benefits

costs and benefits that would occur if a particular course of action were
taken compared to those that would occur if that course of action were not taken.

## Information costs

Transaction costs that include the assessment of the investment merits of a financial asset.
Related: search costs.

## Market impact costs

Also called price impact costs, the result of a bid/ask spread and a dealer's price concession.

## Market timing costs

costs that arise from price movement of the stock during the time of the transaction
which is attributed to other activity in the stock.

## Net financing cost

Also called the cost of carry or, simply, carry, the difference between the cost of financing
the purchase of an asset and the asset's cash yield. Positive carry means that the yield earned is greater than
the financing cost; negative carry means that the financing cost exceeds the yield earned.

## Opportunity cost of capital

Expected return that is foregone by investing in a project rather than in
comparable financial securities.

## Opportunity costs

The difference in the performance of an actual investment and a desired investment
adjusted for fixed costs and execution costs. The performance differential is a consequence of not being able
to implement all desired trades. Most valuable alternative that is given up.

## Price impact costs

Related: market impact costs

## Replacement cost

cost to replace a firm's assets.

## Round-trip transactions costs

costs of completing a transaction, including commissions, market impact
costs, and taxes.

## Search costs

costs associated with locating a counterparty to a trade, including explicit costs (such as
advertising) and implicit costs (such as the value of time). Related:information costs.

## Shortage cost

costs that fall with increases in the level of investment in current assets.

## Sunk costs

costs that have been incurred and cannot be reversed.

## Surplus funds

Cash flow available after payment of taxes in the project.

## Term Fed Funds

Fed funds sold for a period of time longer than overnight.

costs of buying and selling marketable securities and borrowing. Trading costs include

## Transactions costs

The time, effort, and money necessary, including such things as commission fees and the
cost of physically moving the asset from seller to buyer. Related: Round-trip transaction costs, Information
costs, search costs.

## True interest cost

For a security such as commercial paper that is sold on a discount basis, the coupon rate
required to provide an identical return assuming a coupon-bearing instrument of like maturity that pays
interest in arrears.

## 12b-1 funds

Mutual funds that do not charge an upfront or back-end commission, but instead take out up to
1.25% of average daily fund assets each year to cover the costs of selling and marketing shares, an
arrangement allowed by the SEC's Rule 12b-I (passed in 1980).

## Variable cost

A cost that is directly proportional to the volume of output produced. When production is zero,
the variable cost is equal to zero.

## Weighted average cost of capital

Expected return on a portfolio of all the firm's securities. Used as a hurdle
rate for capital investment.

## Cost basis

An assetâ€™s purchase price, plus costs associated with the purchase, like installation fees, taxes, etc.

## Cost of goods sold

The cost of merchandise that a company sold this year. For manufacturing companies, the cost of raw
materials, components, labor and other things that went into producing an item.

## MACRS (Modified Accelerated Cost Recovery System)

A depreciation method created by the IRS under the Tax Reform Act of 1986. Companies must use it to depreciate all plant and equipment assets installed after December 31, 1986 (for tax purposes).

## Absorption costing

A method of costing in which all fixed and variable production costs are charged to products or services using an allocation base.

## Activity-based costing

A method of costing that uses cost pools to accumulate the cost of significant business activities and then assigns the costs from the cost pools to products or services based on cost drivers.

## Avoidable costs

costs that are identifiable with and able to be influenced by decisions made at the business
unit (e.g. division) level.

## Cash cost

The amount of cash expended.

## Cost

A resource sacrificed or forgone to achieve a specific objective (Horngren et al.), defined
typically in monetary terms.

## Cost behaviour

The idea that fixed costs and variable costs react differently to changes in the volume of
products/services produced.

## Cost centre

A division or unit of an organization that is responsible for controlling costs.

## Cost control

The process of either reducing costs while maintaining the same level of productivity or maintaining costs while increasing productivity.

## Cost driver

The most significant cause of the cost of an activity, a measure of the demand for an activity
by each product/service enabling the cost of activities to be assigned from cost pools to products/services.

## Cost object

Anything for which a measurement of cost is required â€“ inputs, processes, outputs or responsibility centres.

## Cost of capital

The costs incurred by an organization to fund all its investments, comprising the risk-adjusted
cost of equity and debt weighted by the mix of equity and debt.

## Cost of goods sold

See cost of sales.

## Cost of manufacture

The cost of goods manufactured for subsequent sale.

## Cost of quality

The difference between the actual costs of production, selling and service and the costs that would be incurred if there were no failures during production or usage of products or services.

## Cost of sales

The manufacture or purchase price of goods sold in a period or the cost of providing a service.

## Cost-plus pricing

A method of pricing in which a mark-up is added to the total product/service cost.

## Cost pool

The costs of (cross-functional) business processes, irrespective of the organizational structure of the business.

## Costâ€“volumeâ€“profit analysis (CVP)

A method for understanding the relationship between revenue, cost and sales volume.

## Direct costs

costs that are readily traceable to particular products or services.

## Fixed costs

costs that do not change with increases or decreases in the volume of goods or services
produced, within the relevant range.

## Full cost

The cost of a product/service that includes an allocation of all the (production and

## Indirect costs

costs that are necessary to produce a product/service but are not readily traceable to particular products or services â€“ see overhead.

## Job costing

A method of accounting that accumulates the costs of a product/service that is produced either
customized to meet a customerâ€™s specification or in a batch of identical product/services.

## Labour oncost

The non-salary or wage costs that follow from the payment of salaries or wages, e.g. National
Insurance and pension contributions.

## Lifecycle costing

An approach to costing that estimates and accumulates the costs of a product/service over
its entire lifecycle, i.e. from inception to abandonment.

## Marginal cost

The cost of producing one extra unit.

## Opportunity cost

The lost opportunity of not doing something, which may be financial or non-financial, e.g. time.

## Period costs

The costs that relate to a period of time.

## Prime cost

The total of all direct costs.

## Process costing

A method of costing for continuous manufacture in which costs for an accounting compared are compared with production for the same period to determine a cost per unit produced.

## Product cost

The cost of goods or services produced.

## Relevant cost

The cost that is relevant to a particular decision â€“ future, incremental cash flows.

## Semi-fixed costs

costs that are constant within a defined level of activity but that can increase or decrease when
activity reaches upper and lower levels.

## Semi-variable costs

costs that have both fixed and variable components.

## Shareholdersâ€™ funds

The capital invested in a business by the shareholders, including retained profits.

## Standard costs

A budget cost for materials and labour used for decision-making, usually expressed as a per unit cost that is applied to standard quantities from a bill of materials and to standard times from a
routing.

## Sunk costs

costs that have been incurred in the past.

## Target costing

A method of costing that is concerned with managing whole-of-life costs of a product/service during the product design phase â€“ the difference between target price (to achieve market share) and the target profit margin.

## Unavoidable cost

A cost that cannot be influenced at the business unit level but is controllable at the corporate level.

## Variable cost

A cost that increases or decreases in proportion with increases or decreases in the volume of production of goods or services.

## Variable costing

A method of costing in which only variable production costs are treated as product costs and in which all fixed (production and non-production) costs are treated as period costs.

## Weighted average cost of capital

See cost of capital.

## Cost of goods sold

The cost of the items that were sold during the current period.

## activity based costing (ABC)

A relatively new method advocated for the
allocation of indirect costs. The key idea is to classify indirect costs,
many of which are fixed in amount for a period of time, into separate
activities and to develop a measure for each activity called a cost driver.
The products or other functions in the business that benefit from the
activity are allocated shares of the total indirect cost for the period based
on their usage as measured by the cost driver.

## capitalization of costs

When a cost is recorded originally as an increase
to an asset account, it is said to be capitalized. This means that the outlay
is treated as a capital expenditure, which becomes part of the total
cost basis of the asset. The alternative is to record the cost as an expense
immediately in the period the cost is incurred. Capitalized costs refer
mainly to costs that are recorded in the long-term operating assets of a
business, such as buildings, machines, equipment, tools, and so on.

## conversion cost

Refers to the sum of manufacturing direct labor and overhead
costs of products. The cost of raw materials used to make products
is not included in this concept. Generally speaking, this is a rough measure
of the value added by the manufacturing process.

## cost of capital

Refers to the interest cost of debt capital used by a business
plus the amount of profit that the business should earn for its equity
sources of capital to justify the use of the equity capital during the
period. Interest is a contractual and definite amount for a period,
whereas the profit that a business should earn on the equity capital
employed during the period is not. A business should set a definite goal
of earning at least a certain minimum return on equity (ROE) and compare
its actual performance for the period against this goal. The costs of
debt and equity capital are combined into either a before-tax rate or an
after-tax rate for capital investment analysis.