Financial Terms related to Cost This document is part of the valuable contents available at www.ftpall.com, a free online glossary with more than five thousand financial and business terms. This document can be copied and distributed freely Find thousands of financial terms at www.ftpall.com respecting its original format. It is forbidden its transcription, translation or change on its format without authorization of its author or editor. COST Accelerated cost recovery system • Abbreviated ACRS. Schedule of depreciation rates allowed for tax purposes. Agency cost view • The argument that specifies that the various agency costs create a complex environment in which total agency costs are at a minimum with some, but less than 100%, debt financing. Agency costs • The incremental costs of having an agent make decisions for a principal. • Costs borne by shareholders to prevent or minimize agency problems and to contribute to the maximization of the owners' wealth. They include monitoring and bonding expenditures, opportunity costs, and structuring expenditures. All in cost • Total costs, explicit and implicit. www.ftpall.com 2|Page • Total costs, explicit and other. Example: The all-in cost to a bank of CD money is the explicit rate of interest it pays on that deposit plus the FDIC premium it must pay on the deposit plus the hidden cost it incurs because it must hold some portion of that deposit in a non-interest-bearing reserve account at the Fed. Average cost of capital • A firm's required payout to the bondholders and to the stockholders expressed as a percentage of capital contributed to the firm. Average cost of capital is computed by dividing the total required cost of capital by the total amount of contributed capital. Find thousands of financial terms at www.ftpall.com Bankruptcy cost view • The argument that expected indirect and direct bankruptcy costs offset the other benefits from leverage so that the optimal amount of leverage is less than 100% debt financing. Break even analysis cost volume profit analysis • Indicates the level of operations necessary to cover all operating costs and the profitability associated with various levels of sales. Capital cost allowance • Abbreviated CCA. The term for the amortization system that must be used for income tax purposes when reporting to Canada Customs and Revenue Agency. It is a non-cash expense that increases cash flow. Carring costs • Costs that increase with increases in the level of investment in current assets. Carrying costs • The variable costs per unit of holding an item in inventory for a specified time period. Cost basis www.ftpall.com 3|Page • See Basis. Cost benefit ratio • The net present value of an investment divided by the investment's initial cost. Also called the profitability index. Cost company arrangement • Arrangement whereby the shareholders of a project receive output free of charge but agree to pay all operating and financing charges of the project. Find thousands of financial terms at www.ftpall.com Cost of a new issue of common stock • Determined by calculating the cost of common stock after considering both the amount of underpricing and the associated flotation costs. Cost of capital • The required return for a capital budgeting project. • The minimum rate of return that a firm must earn on its project investments to maintain its market value and attract needed funds. This rate of return is based on the mix of debt and common equity financing. • This is the price of capital. When corporations borrow, they pay interest, which is called the cost of debt capital. In the context of valuing firms, the discount rate is called the cost of capital. Cost of carry • Related: Net financing cost Cost of common equity • The rate at which investors discount the expected dividends of the firm to determine its share value: the required rate of return investors demand for holding the common shares of the company. www.ftpall.com 4|Page Cost of debt • Denotes the interest rate paid to bondholders. In the context of valuing firms, if the capital is debt, the cost of capital is called the cost of debt (synonymous with "yield"). Cost of equity • This is the price companies pay to raise equity capital. Denotes dividends and capital gains paid to the shareholders. In the context of valuing firms, if the capital is equity, then the cost of capital is called cost of equity. Find thousands of financial terms at www.ftpall.com Cost of funds • Interest rate associated with borrowing money. Cost of funds index • Is a benchmark used for resetting the coupon rate on an adjustable rate mortgage. Frequently, this is based on the cost of the 11th District Federal Home Loan Bankfunds. This district includes Arizona, California and Nevada. Cost of giving up a cash discount • The implied rate of interest paid to delay payment of an account payable for an additional number of days. Cost of goods sold • Costs directly related to sales, such as product from inventory Cost of lease financing • A lease's internal rate of return. Cost of limited partner capital • The discount rate that equates the after-tax inflows with outflows for capital raised from limited partners. Cost of living adjustment www.ftpall.com 5|Page • Abbreviated COLA. An increase in a pension or annuity benefit to compensate for an increase in the cost of living. Cost of long term debt • The after tax cost today of raising long-term funds through borrowing. Cost of new asset • The net outflow required to acquire a new asset. Cost of preferred stock Find thousands of financial terms at www.ftpall.com • The relationship between the cost of the preferred equity and the amount o funds provided by the preferred share issue: found by dividing the annual preferred share dividend, by the net proceeds from the sale of the preferred stock. Cost of retained earnings • Since reinvested profits are common shareholders' money, these funds have a cost which is the cost of common equity, ks. Cost yield • The annual income from an investment divided by the purchase cost. Because it does not include the effect of premiums and discounts which may have been included in the purchase cost, it is an incomplete measure of return. Dollar cost averaging • Is the practice of purchasing securities at periodic intervals with fixed dollar amounts regardless of market conditions. The investor does not intend to purchase an equal number of shares at each interval. • Systematically investing the same amount of money in the same stock or group of stocks. • A technique of buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price; thus purchasing more shares when prices www.ftpall.com 6|Page are low, and fewer shares when prices are high. Over time, the average cost per share of the security will become smaller. This method attempts to lessen the risk of investing a large amount in a single investment at the wrong time. Used with Mutual Funds and Dividend Reinvestment Plans. Equivalent annual cost • The equivalent cost per year of owning an asset over its entire life. Execution costs Find thousands of financial terms at www.ftpall.com • The difference between the execution price of a security and the price that would have existed in the absence of a trade, which can be further divided into market impact costs and market timing costs. Financial distress costs • Legal and administrative costs of liquidation or reorganization. Also includes implied costs associated with impaired ability to do business (indirect costs). Fixed cost • A cost that is fixed in total for a given period of time and for given production levels. Floatation costs • The total costs of issuing and selling a security. Includes the underwriters discount, legal, accounting fees and fees paid to regulators. Flotation costs • The total costs of issuing and selling a security. Friction costs • Costs, both implied and direct, associated with a transaction. Such costs include time, effort, money, and associated tax effects of gathering information and making a transaction. www.ftpall.com 7|Page Incremental cost of a new asset • The total of all costs incurred to get an asset to the point of being able to produce cash inflows for the company, less the proceeds from the sale of an old asset, often the asset being replaced. Incremental costs and benefits • Costs and benefits that would occur if a particular course of action were taken compared to those that would occur if that course of action were not taken. Find thousands of financial terms at www.ftpall.com Information costs • Transaction costs that include the assessment of the investment merits of a financial asset. Related: search costs. Installation cost • Costs incurred to place equipment or machinery into operation. Installed cost of new asset • The cost of the asset plus its installation costs; equals the asset's depreciable value. Marginal cost of capital • Abbreviated MMC. The firm's weighted average cost of capital (WACC) associated with its next dollar of total new financing. Marginal cost of capital schedule • Graph that relates the firm's weighted average cost of capital (WACC) to the level of total new financing. Market impact costs • Also called price impact costs, the result of a bid/ask spread and a dealer's price concession. www.ftpall.com 8|Page Market timing costs • Costs that arise from price movement of the stock during the time of the transaction which is attributed to other activity in the stock. Net financing cost • Also called the cost of carry or, simply, carry, the difference between the cost of financing the purchase of an asset and the asset's cash yield. Positive carry means that the yield earned is greater than the financing cost; negative carry means that the financing cost exceeds the yield earned. Find thousands of financial terms at www.ftpall.com Opportunity cost • The difference in the performance of an actual investment and a desired investment adjusted for fixed costs and execution costs. The performance differential is a consequence of not being able to implement all desired trades. Most valuable alternative that is given up. • Cash flows that could be realized from the best alternative use of an owned asset. • The cost of pursuing one course of action measured in terms of the foregone return offered by the most attractive alternative. Opportunity cost of capital • Expected return that is foregone by investing in a project rather than in comparable financial securities. Order costs • The fixed costs of placing, receiving and handling an inventory order. Overhead costs • Costs and expenses that cannot be directly matched to a product or sale, for example property tax Price impact costs www.ftpall.com 9|Page • Related: market impact costs Product cost • The purchase cost of goods sold by a wholesaler or retainer or for a manufactured product the total of direct material, direct labor, variable and fixed manufacturing overhead Replacement cost • Cost to replace a firm's assets. Find thousands of financial terms at www.ftpall.com Round trip transactions costs • Costs of completing a transaction, including commissions, market impactcosts, and taxes. Search costs • Costs associated with locating counterparty to a trade, including explicit costs (such as advertising) and implicit costs (such as the value of time). Related: information costs. Shortage cost • Costs that fall with increases in the level of investment in current assets. Sunk costs • Cash outlays that have already been made (ie., past outlays) and therefore have no effect on the cash flows relevant to a current decision. • Costs that have been incurred and cannot be reversed. Total cost of inventory • The sum of the order costs and carrying costs of inventory. Trading costs • Costs of buying and selling marketable securities and borrowing. Trading costs www.ftpall.com 10 | P a g e include commissions, slippage, and the bid/ask spread. See: transaction costs. Transaction costs • Costs incurred buying or selling securities. These include brokers' commissions and dealers' Spreads (the difference between the price the dealer paid for a security and for which he can sell it). Transactions costs • The time, effort, and money necessary, including such things as commission fees Find thousands of financial terms at www.ftpall.com and the cost of physically moving the asset from seller to buyer. Related: Round-trip transaction costs, Information costs, search costs. True interest cost • For a security such as commercial paper that is sold on a discount basis, the coupon rate required to provide an identical return assuming a coupon-bearing instrument of like maturity that pays interest in arrears. Variable cost • A cost that is directly proportional to the volume of output produced. When production is zero, the variable cost is equal to zero. Weighted average cost of capital • Abbreviated WACC. Reflects the expected average future cost of funds for the upcoming year; found by weighting the cost of each specific type of capital by its proportion in the firm's capital structure. • The average cost of all capital used by a firm. In the context of valuing firms, if the capital is a mixture of debt and equity. The discount rate is called weighted average cost of capital. WACC = (1 - tc) * Rd * D/(D+E) + Re * E/ (D+E) Where tc is the corporate tax rate , Rd is the contractual interest rate on (new) debt, Re is the discount rate on equity, D and E are the market values of debt and equity www.ftpall.com 11 | P a g e respectively. The return of all projects accepted by the corporation must exceed the weighted average cost of capital (WACC) to create value for the shareholders. • Expected return on a portfolio of all the firm's securities. Used as a hurdle rate for capital investment. Zero cost collar • The price of call equals the price of put in a collar. See collars. • Is a transaction which has little or zero cash outlay or cost for the initiating person. Find thousands of financial terms at www.ftpall.com Often, a security is held and some protection is sought via a hedging transaction. One example, would be the purchase of an out-of-the-money put (debit) and the sale of an out-of-the-money call (credit). Here, the premiums for the debit and credit are nearly the same. Therefore, there would be little or no cost for the person seeking the hedge. However, this position places a cap on the potential reward for holding the underlying asset. Essentially, the protection does not kick-in until the price of the underlying instrument goes below the exercise price for the put. Generally speaking, it should be noted that if the hedge occurred with both options at-the-money, then the person replicated a synthetic short against an actual long position. For the latter, the hedge would be considered as delta neutral whereas using two out-of-the-money options, the hedge at the origination would not be delta neutral. Rather, it would be computed as a partial hedge when placed.