Increasing Cost of Funds

Increasing Cost of Funds

Class Notes

For volume of investments at time period zero;
Retained earnings are typically considered to have a 'high certainty'.
Commercial loans are considered to have some uncertainty.
Capitol market, stocks, and bonds are highly uncertain.

Note: Like returns that are 'certain' even if not so large.

Indivisible Assets Divisible Asset
Find Blended incremental cost of funds Take part that has IRR>=MARR

Note: If blended MARR>=IRR, then buy it.

Classroom Notes:

Ex1:

MARR: 10%

5 Choices:

A (irr=25%, scale of investment=\$5)

B (irr=20%, scale of investment=\$15)

C (irr=15%, scale of investment=\$10)

D (irr=12%, scale of investment=\$5)

E (irr=8%, scale of investment=\$10)

- Choose: A, B, C, D because irr > MARR. Dont Choose: E because irr < MARR (8% < 10%)

Ex2:

MARR=10%

Same 5 choices as Ex1

This time retained earnings gives you only \$30 for scale of investment purchases. You purchase A, B, C and now have to decide…do you take a loan at 17% and purchase D and E?

• D only gets you a irr = 12% which is not greater than the 17% of loan so no to D
• E only gets you a irr = 8% which is not greater than the 17% of loan so no to E as well.

Ex3:

MARR=10%

Same 5 choices as Ex1

This time retained earnings gives you only \$25 for scale of investment purchases. You purchase A and B and you have 2 ways you can look at purchasing C:

• Divisible Asset: Divide C in half and get C1 and C2. C1 can be payed for with retained earnings (\$5 you have left over) and C2 can be payed with a loan. Buy C1, but do not buy C2 because the irr for C = 15% and the loan is 17%.
• Indivisible Asset (asset you cant divide. ie…truck, car, etc.): 5/10*10%(retained earnings)+5/10*17%(loan) = 13.5% which is more than the MARR (10%) so buy.

Ex 4:
\$6 available to invest at MARR = 10% Loan Rate = 12%