1. What is the Cost of Money Formula?

The Cost of Money formula represents the total expense associated with using capital, combining both explicit interest costs and implicit opportunity costs. It provides a comprehensive view of the true cost of financial resources.

2. How Does the Calculator Work?

The calculator uses the Cost of Money formula:

Where:

• \( \text{Interest Rate} \) — Explicit interest rate paid on borrowed funds (%)
• \( \text{Opportunity Cost} \) — Return foregone from next best alternative investment (%)
• \( \text{Cost of Money} \) — Total cost including both explicit and implicit costs (%)

Explanation: This formula captures both the direct financial costs (interest) and the indirect costs (missed opportunities) of using capital.

3. Importance of Cost of Money Calculation

Details: Understanding the total cost of money is essential for investment decisions, capital budgeting, financial planning, and evaluating the true profitability of projects and investments.

4. Using the Calculator

Tips: Enter interest rate and opportunity cost as percentages. Both values must be non-negative numbers representing the respective costs in percentage terms.

5. Frequently Asked Questions (FAQ)

Q1: What is the difference between interest rate and opportunity cost?
A: Interest rate is the explicit cost of borrowing money, while opportunity cost represents the potential returns lost by choosing one investment over another.

Q2: How do I determine the opportunity cost?
A: Opportunity cost is typically the rate of return you could earn from the next best alternative investment with similar risk characteristics.

Q3: Why is cost of money important for businesses?
A: It helps businesses make informed decisions about financing, investment opportunities, and capital allocation to maximize shareholder value.

Q4: Does cost of money vary by industry?
A: Yes, different industries have varying risk profiles, capital requirements, and alternative investment opportunities, affecting their cost of money.

Q5: How does inflation affect cost of money?
A: Inflation increases both interest rates and opportunity costs, as investors require higher returns to compensate for the decreasing purchasing power of money.