7. Cost of money

Everyone uses money, and it is important to understand what factors affect the cost of money.

Consider the following scenario:

A friend comes to you and asks you to invest in his business instead of investing in Treasury bonds. You think he has a good business model, so you tell him you are willing to invest as long as the expected return on the investment is at least four times the return you would have received on the Treasury bonds.

Determine which of these fundamental factors is affecting the cost of money in the scenario described:

Inflation

Risk

Time preferences for consumption

Roberto recently started a new business with money that he collected from his friends and family. All other factors being equal, which of the following financing options has a higher cost for someone who needs capital to start a business?

Sheila expects to earn a return of 10% on her investment in Robertos business for the next two years, but restricts Roberto to not finance his business with debt beyond 40% of the total capital needed.

Veronica invested in Robertos business and expects to earn a 10% rate of return every year for the next two years, irrespective of how much debt financing Roberto uses.