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Math Help - True Funding Cost

  1. #1
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    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.
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  2. #2
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    Quote Originally Posted by eochu View Post
    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...
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  3. #3
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    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.
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  4. #4
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    Quote Originally Posted by eochu View Post
    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.
    .
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