How much am I risking by carrying out this experiment?
To calculate the opportunity cost of this experiment, I need to calculate the lost income and increased costs that I am likely to face as a result of this experiment.
§ Lost income from work - £337 a month or £4,044 for the duration of The Experiment. This includes reducing my current salary to 75% of its current level (plus a small increase for inflation) as well as foregoing 25% of an estimated performance related bonus for the 12 months of The Experiment. (Incidentally, reducing my salary by 25% only leads to a reduction of 20% in my net pay due to tax deductions and student loan deductions decreasing.)
§ Increased travelling costs – Since my girlfriend and I both work for the same company, we obviously benefit from reduced travelling costs as we share a car to work. As a result of The Experiment, our travelling costs will increase by circa. £100 a month or £1,200 a year.
§ Software costs – I need to invest in some software (Bet Angel Pro) to enable me to carry out The Experiment in an appropriate manner. This software will cost me £320 for the duration of The Experiment.
In total, the opportunity cost of this experiment is £5,564 for 12 months. This is equivalent to £464 a month. Of course, this excludes the capital required to carry out The Experiment in the first place!
How do I plan to fund this experiment?
I believe that there are only two ways to fund the £15,000 capital that I need to carry out this experiment. These are a Personal Loan of £15k or increasing my mortgage by £15k. The figures for both options are:
o Personal Loan
Ø A £15k loan across 5 years means that I would have to pay £3k in interest repayments.
Ø My monthly repayment would be £300 for 60 months.
o Increased Mortgage
Ø Increasing my mortgage by £15k would result in me having to pay around £13k in interest payments across the next 24 years.
Ø My increased monthly repayment would be around £100 a month for the next 24 years (varies depending on interest rate changes).
I believe that the mortgage option is the correct finance option for me as it is basically a risk-free option. If The Experiment fails, I could easily afford to be penalised by paying an extra £100 a month towards my mortgage. However, if The Experiment were to fail, I would be heavily penalised by the Personal Loan option as I would struggle to meet the repayments of £300 a month without changing my lifestyle.
As I don’t want to be paying an extra £100 towards my mortgage for the next 24 years, I am going to aim to pay back the £15k in 5 years time. Hence, I effectively get a £15k loan for a reduced interest rate with the safety-net of knowing that if The Experiment fails, I will only have to meet repayments of £100 a month (although it would be for 24 years!)
Cost of Capital Financing
As stated above, I want to pay back the £15k in 5 years time. Until I pay this back, I will face interest payments of £100 a month. Hence, the cost of the loan is effectively:
Finance Cost = £100 a month for 60 months and £15k at month 60.
For simplicity, if we exclude discounting, the cost to me is £21,000 over 5 years or £350 a month.
By looking at the opportunity cost of this experiment, I can see that the cost to me every month for carrying out this experiment is around £814 a month! This of course assumed that I want to pay my £15k loan back at the end of 5 years. If I decided to live with the increased mortgage costs for the next 24 years, the cost to me every month is around £564. Whatever way you look at it, it’s going to be an expensive experiment……..