# True Funding Cost

• Nov 3rd 2009, 04:20 PM
eochu
True Funding Cost
Hi,

I have been taught that calculating the true funding cost is more accurate using method 1 than method 2 (shown below):

[Vars: Fa=percentage funding cost, P=amount of money raised, T=true funding cost]

1. T = P/(1-Fa)

2. T = P + P*Fa

Why is this so? Why do they not equal each other?

Your help is much appreciated.
• Nov 3rd 2009, 07:37 PM
Wilmer
Quote:

Originally Posted by eochu
I have been taught that calculating the true funding cost is more accurate using method 1 than method 2 (shown below):
[Vars: Fa=percentage funding cost, P=amount of money raised, T=true funding cost]
1. T = P/(1-Fa)
2. T = P + P*Fa
Why is this so? Why do they not equal each other?

Make T = 1000 and Fa = .05 (5%)
1000 / (1 - .05) = 1000 / .95 = 1052.63
1000 + 1000(.05) = 1000 + 50 = 1050.00

Any example will be similar...
• Nov 3rd 2009, 09:25 PM
eochu
Hi,

Thanks for your reply. I know they give similar answers but I want to know why they are different and why one is prefered over the other.
• Nov 3rd 2009, 10:54 PM
aidan
Quote:

Originally Posted by eochu
Hi,

Thanks for your reply. I know they give similar answers but I want to know why they are different and why one is prefered over the other.

As Wilmer has shown there is a slight difference in the formulae.

In general, the COST required to raise money is deducted from the TOTAL amount of money raised.
If you are to raise some money & you spend a few dollars for postage, telephone, gasoline, office space, and so forth, you expect to be repaid your out of pocket expenditures. Say you raise \$1000 and your total costs were \$50, or 5% of the amount raised.
However, the fund would not report income of \$1000. The fund would deduct your costs (5%) from the \$1000 and then record \$950 as the amount raised.
Note: If you had raised \$1052.63 and then deduct the 5% (5% of 1052.63 is \$52.63) the fund would report and income of \$1000.
It cost an additional \$2.63 to raise the additional \$50.
In this example:
T = P/(1-Fa)
The cost to raise the money is deducted from the money raised.

If the fund has a benefactor (or an isolated method of paying for costs (your out of pocket money), then your expense would be paid by a different source -- or more likely you'd say just forget about the minor expenses; you absorb the cost or don't require coverage for your small expenditures. The fund would report that \$1000 had been raised (at zero cost to the fund).
T = P(1+Fa)
The cost to raise the money is paid by someone else.

Hope that is meaningful.
.