How to Calculate Financing Costs for Conservative Strategy

by Eric Feigenbaum

When companies undertake projects such construction or product development, they have several ways to fund them. Conservative strategies involve borrowing the full amount of money required to complete the project in advance. This is considered conservative because executives know they have all the funds required and won't face unexpected financing hitches down the line. However, this usually costs more than an aggressive strategy, which employs a mixture of short- and long-term loans. This is because the company pays interest even when it is not using all the money. However, a single loan makes conservative strategy financing easy to calculate.

Determine the amount of money your project requires from start to finish. A conservative strategy takes into account all costs to ensure that there will be no shortage of funds that could interfere with a project's completion.

Decide on the term of your desired loan. Banks and financiers offer loan terms ranging from one to 30 years. The longer you maintain a loan, the more interest you will pay. Figure out how long the project will take and how long you can reasonably expect a return on your investment. Take a loan for no longer than you really need it.

Obtain a quote on the interest rate for the desired loan. The cost of the project can change dramatically based on the interest you will have to pay.

Multiply the loan principal by the rate of interest. This tells you how much interest you will pay per year. For example, if the company borrows $2 million at an 8 percent annual interest rate, then you will multiply 2 million by .08 to get $160,000, which is the cost of borrowing $2 million for one year.

Multiply the amount of interest per year by the term for the loan. This is the total financing cost for your conservative strategy. Accordingly, if you pay back a $2 million loan at 8 percent interest in full, at the end of five years you will pay $160,000 in interest five times, totaling $800,000.

Tip

  • Although amortized loans are not common to business financing, they can result in overall lower interest costs because the company is paying down principal throughout the life of the loan.

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