Cost of Funds Calculator

The Cost of Funds Calculator is a vital tool for businesses, especially financial institutions, to calculate the total cost of raising funds through both liabilities (e.g., loans, deposits, bonds) and equity. By determining the cost of funds, businesses can better manage their capital structure, make informed financial decisions, and maintain profitability.

This calculator evaluates the weighted average cost of liabilities, the cost of equity, and the total capital to determine how much it costs a company to source its funds. It’s especially useful for banks, investment firms, and businesses that rely on external financing.

Formula of Cost of Funds Calculator

The formula for calculating the cost of funds is:

Cost of Funds = (Weighted Average Cost of Liabilities + Cost of Equity) / Total Capital

Detailed Breakdown

1. Weighted Average Cost of Liabilities

The cost of borrowed funds from various sources, weighted by their proportion of total liabilities.
Weighted Average Cost of Liabilities = (Sum of Individual Liabilities × Their Respective Costs) / Total Liabilities

• Individual Liabilities: Different sources of borrowed funds, such as customer deposits, bonds, and loans.
• Their Respective Costs: The interest rates or expenses associated with each liability.
• Respective Costs of Liabilities Formula:
  Respective Costs = Interest Expense on Liability / Liability Amount

2. Cost of Equity

The return required by shareholders to invest in the company. This can be calculated using:

CAPM Formula:
Cost of Equity = Risk-Free Rate + Beta × (Market Return − Risk-Free Rate)

DDM Formula:
Cost of Equity = (Next Year’s Dividend / Current Stock Price) + Dividend Growth Rate

• Next Year’s Dividend Formula:
  Next Year’s Dividend = Current Dividend × (1 + Dividend Growth Rate)
• Dividend Growth Rate Formula:
  Dividend Growth Rate = (Recent Dividend − Previous Dividend) / Previous Dividend × 100

3. Total Capital

The sum of all liabilities and equity:
Total Capital = Total Liabilities + Total Equity

Additional Variable Formulas

Variable	Formula
Respective Costs of Liabilities	Interest Expense on Liability / Liability Amount
Next Year’s Dividend	Current Dividend × (1 + Dividend Growth Rate)
Dividend Growth Rate	(Recent Dividend − Previous Dividend) / Previous Dividend × 100
Market Return	(Ending Market Value − Beginning Market Value + Dividends) / Beginning Market Value

General Terms Table

Below is a table with common values and their ranges to guide users in estimating variables:

Variable	Typical Value Range	Notes
Risk-Free Rate (%)	2–5	Based on government bonds
Beta	0.5–2	Higher values indicate higher market risk
Market Return (%)	8–12	Based on historical market averages
Cost of Liabilities (%)	3–8	Varies by source of borrowing
Dividend Growth Rate (%)	3–8	Dependent on company growth projections

Example of Cost of Funds Calculator

Scenario:

A financial institution has the following data:

• Total Liabilities: $10,000,000
• Equity: $5,000,000
• Liabilities Breakdown:
  • $5,000,000 in customer deposits with a 3% cost
  • $3,000,000 in bonds with a 5% cost
  • $2,000,000 in loans with a 4% cost
• Risk-Free Rate: 3%
• Beta: 1.2
• Market Return: 10%

Step 1: Calculate Weighted Average Cost of Liabilities

Weighted Average Cost of Liabilities = (Sum of Individual Liabilities × Their Costs) / Total Liabilities
Cost of Liabilities = (($5,000,000 × 3%) + ($3,000,000 × 5%) + ($2,000,000 × 4%)) / $10,000,000
Cost of Liabilities = ($150,000 + $150,000 + $80,000) / $10,000,000 = $380,000 / $10,000,000 = 3.8%

Step 2: Calculate Cost of Equity Using CAPM

Cost of Equity = Risk-Free Rate + Beta × (Market Return − Risk-Free Rate)
Cost of Equity = 3% + 1.2 × 7% = 3% + 8.4% = 11.4%

Step 3: Calculate Total Capital

Total Capital = Total Liabilities + Equity
Total Capital = $10,000,000 + $5,000,000 = $15,000,000

Step 4: Calculate Cost of Funds

Cost of Funds = (Weighted Average Cost of Liabilities + Cost of Equity) / Total Capital
Cost of Funds = (3.8% + 11.4%) / $15,000,000 = 15.2% / $15,000,000 = 0.01013 or approximately 1.013%

Interpretation:

The financial institution’s cost of funds is approximately 1.013%, indicating the cost efficiency of its funding structure.

Most Common FAQs