The incremental cost of borrowing represents the effective additional cost that a company incurs for securing more debt on top of its existing obligations. This cost is determined by the interest rate applicable to the new debt and any fees or expenses associated with obtaining it.

For example, if a company has an existing loan at an interest rate of 4% and is considering acquiring additional financing at an interest rate of 5%, the incremental cost is primarily determined by the terms and interest rate of the new loan. Factors such as the duration of the loan, collateral requirements, and the company’s credit score can influence the terms and therefore the incremental cost.

This metric is vital for decision-making as it helps businesses evaluate whether taking on extra debt will be beneficial after considering the potential return on investment (ROI) of the borrowed funds versus the borrowing cost. Organizations often compare incremental costs among different financing options to minimize expenses and maximize financial efficiency, which relates to Financial Planning, as it incorporates these costs in financial projections and planning.