Cost of Short-Term Funds - Financial Management

Managers need a method to calculate the financing cost for the various sources of short-term financing available to a firm. gives the amount of interest paid, I, on borrowed money:

I = PV0*i *n

where I = the interest amount in dollars; PV0 = the principal amount at time 0, or the present value; i = the interest rate per time period; and n = the number of time periods. Solving for i, we obtain

i = I/PV0 * 1/n

The interest rate, i, is equal to the fractional interest cost per period, I/PV0, times 1 divided by the number of time periods, or 1/n.

The equation we use to calculate the annual financing cost,AFC, for short-term financing sources is a variation of

AFC=(Interest costs+fees)/Usable funds*365/maturity(days)

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Financial Management Topics