This is the price the company pays to obtain and retail finance. To obtain finance a company will pay implicit costs which are commonly known as floatation costs. These include: Underwriting commission, Brokerage costs, cost of printing a prospectus, Commission costs, legal fees, audit costs, cost of printing share
certificates, advertising costs etc. For debt there are legal fees, valuation costs (i.e. security, audit fees, Bankers commission etc.)
Factors That Influence the Cost of Finance
- Terms of reference – if short term, the cost is usually low and vice versa.
- Economic conditions prevailing – If a company is operating under inflationary conditions, such a company will pay high costs in so far as inflationary effect of finance will be passed onto the company.
- Risk exposed to venture – if a company is operating under high risk conditions, such a company will pay high costs to induce lenders to avail finance to it because the element of risk will be added on the cost of finance which may compound it.
- Size of the business – A small company will find it difficult to raise finance and as such will pay heavily in form of cost of finance to obtain debt from lenders.
- Availability – Cost of finance (COF) prices will also be influenced by the forces of demand and supply such that low demand and low supply will lead to high cost of finance.
- Effects of taxation – Debt finance is cheaper by the amount equal to tax on interest and this means that debt finance will entail a saving in cost of finance equivalent to tax on interest.
- Nature of security – If security given depreciates fast, then this will compound implicit costs (costs of maintaining that security).
- Company’s growth stage – Young companies usually pay less dividends in which case the cost of this finance will be relatively cheaper at the earlier stages of the company’s development