Cost of capital

The level of cost of capital varies significantly on its individual elements (components). An element of capital in the process of assessing its value refers to each of its variety of individual sources of the formation of (attracting). As these elements serves the capital, attracted by:

1) Reinvestment of profits received by the company (retained earnings);

2) Issue of preference shares;

3) Issue of common shares;

4) Obtaining a bank loan;

4) Bond;

5) financial leasing, etc.

For a comparable assessment of the cost of each item of capital is expressed in the annual rate of interest. The level value of each item of capital is not constant and varies considerably over time under the influence of various factors.

2.6.Sources means of financing the organization

Analysis of the structure of liabilities balance that characterizes the sources of funds, shows that their main categories are: internal sources (the share capital, fund equity, retained earnings); borrowings (loans of banks (long-and short-term) bond loans); temporary borrowings (payables).

Short-term payables for goods (works, services) on wages and taxes in the calculation does not take part because the organization does not pay for her interest and she is a consequence of current operations during the year, while the calculation of the cost of capital is held for a year for long-term solutions.

Short-term bank loans are usually temporarily hired to finance current production needs for working capital, so they are also not taken into account when calculating the cost of capital.

Thus, to determine the cost of capital the most important are his sources: 1) the borrowed funds, which include long-term loans and bond issues, and 2) own funds, which include common and preferred shares and retained earnings.

Depending on the duration of existence in this particular form of the organization's assets, as well as sources of funds are divided into short-term (current) and long-term. As a rule, it is assumed that the current assets are financed through short-term, and capital assets - at the expense of long-term sources of funds; optimizes total cost of raising funds. In this tutorial, under the capital we have in mind, as a rule, long-term sources of funds. In this case, we consider only one aspect of management - the cost of the source, and only those sources of funds mobilization and maintenance of which are associated with obvious regular cost.

Chapter 3: The cost of capital as an indicator of financial performance

Cost of capital - the total amount of funds that must be paid for the use of a certain amount of financial resources, expressed as a percentage of this volume of financial resources.

Optimizing the sum of the costs of raising capital is achieved by ensuring that the current assets are financed from short-term sources of durable assets - from long-term sources. In this case, the term "capital cost" we do not use to mean "value of the company" or "capital appreciation". The cost of capital is expressed quantitatively by the relative annual costs of servicing its debt to the owners and investors.

Main objective of determining the cost of capital is to determine the limiting value of the cost of capital from the perspective of its development. In other words, the cost of capital will be determined by the value of its individual elements, equity and debt, depending on the sources of formation, the rate in effect is calculated, ambiguous, subjective and stochastic.

The process of determining the cost of capital as one element of performance assessment in financial management is not an end in itself. Calculating the cost of capital allows us to solve a number of key financial management tasks:

• The indicator reflects the impact of capital funds invested by investors in the resources involved in the turnover of the company, therefore, the cost of capital can be used in determining the market valuation of equity companies in the process of forecasting the price of the shares of the company depending on the level of profitability and dividend yield.

• The cost of borrowing sources of capital formation allows us to characterize the quality of financial management solutions to manage individual elements of debt, which ultimately allows you to optimize solutions for managing specific sources of debt and the impact on profitability and market price of the company.

• Minimize the cost of capital is one of the factors that increase the market price of the company, which is known, is the main purpose of the financial management of the company.

• The indicator characterizes the perspective of the cost of capital of the company and serves as a reference in determining its attractiveness, is the basis of formation of an investment company's budget and is a factor in the amount of investment.

The concept of cost of capital is one of the basic theories of cost of capital. Determining the cost of capital is not only to calculate the amount of cash to meet obligations to the holders of the consumed financial resources. The cost of capital gives an estimate of the return on invested capital, which should ensure the company is not reducing its market value.

Capital involved in the process of commercial activity as a productive factor, represents an investment resource that has a definite value for a company that uses it. The essence of the concept of cost of capital lies in the fact that different elements of capital, this value will vary at different levels, which ultimately will serve as a kind of assessment of financial management related to the attraction of capital turnover. Clearly, the value of elements of capital is important to consider and, eventually, it will affect the level of other targets, financial management system.

Estimating the cost of capital the company has consistently ¬ us to implementation in three phases:

• Assess the cost of equity and ¬ separate elements;

• Assess the cost of debt capital and its individual elements;

• Assessment of the weighted average cost of capital.

Cost of equity

To determine the value of their own headband takes into account its basic elements:

• Proper functioning capital of the company;

• Additional capital raised by issuing preference shares and ordinary shares.

These statements allow the company to determine the value of its own functioning capital company. For this assessment process considers:

• The average for the period book value of equity. The index is used as a base adjustment to the amount of equity, given its current market valuation. In this case, to calculate the cost of equity capital using the method of average chronological;

• The average for the period current market assessments used by equity;

• The amount of payments from the company's net profit to the owners of capital in the form of interest, dividends, etc. In fact, this amount represents the price the company pays for the use of capital owners. Most often, this price is set by the owners, which determine the amount of interest or dividends on equity in the distribution of net profit.

Cost-functioning equity of the company during the period determined by the formula

                             , ,

Where - the cost of a functioning equity of the company during the reporting period,%;

  - The amount of net profit paid to the owners of the company during its distribution in the period;

  - The average amount of equity capital of the company during the reporting period.

Cost-functioning equity during the reporting period could be the basis for calculating the cost of routine functioning of equity. Sphere of functioning of equity in an operating activity, so target is the cost of equity is dependent on the dynamo payments of profits to the owners of the invested capital. Consequently, the cost of functioning of equity in the planning period is determined by the formula

                              , ,

Where - the cost of functioning of equity companies in the planning period, %;

  - Cost-functioning equity of the company during the reporting period, %;

  - Projected growth rate of payments of profits to owners per unit of invested capital, expressed as a decimal fraction.

Advanced attracted equity (stock) capital is estimated differentially on preferred shares and common shares, as well as increase awareness units.

The cost of raising additional capital by issuing preferred shares is determined by taking into account the fixed ¬  finite size of dividends, which is defined by him in advance. In this case, the service obligations of preferred shares vinyl largely coincides with the commitment to serve the debt capital, which helps simplify the process of determining the value of this element mint of capital. However, for the capital mobilized through the issuance of preferred shares, there is a significant difference in the character of his service. Payment of debt service included in cost of products and services company, respectively, is not subject to taxation in the profit. Dividend payments on preferred shares shall be covered by net income, and therefore taxed at the rate of taxation of company profits. An additional element of the cost of mobilizing private capital through the issuance of preferred shares is the emission costs of issuing shares, referred to as "cost allocation". Thus, with these features cost an additional raise capital by issuing preferred shares is determined by the formula

                              ,

 Where - the cost of equity capital, to increase awareness by issuing preferred shares,%;

  - The amount of dividends provided for payment in accordance ¬ dance with the contractual obligations of the issuer;

  - The amount of equity, leverage, through the issue of preference shares;

EZ - the ratio of expenses on issue of shares to the amount of emissions, expressed as a decimal fraction.

The cost of raising additional capital by issuing common shares (or additionally attracted interest) in the calculation is based on the indicators:

• the amount of additional issue of ordinary shares (or amount attracted additional units);

• The amount of dividends paid during the period of one share (or the amount of profit paid out to owners on unit of capital);

• Planned growth rate of profits paid to owners capital in the form of dividends (or interest);

• planned expenditure on issue of shares (or attract additional equity capital).

This element of equity to value is the most expensive because the costs of the service does not include the cost and the amount paid from the net profit increases with the high risk premium due to the fact that this capital during the bankruptcy of the company is protected in the least degree.

Calculating the cost of additional capital, attracted by issuing common shares (additional shares), carried by the following formula

                            ,

 Where - the cost of equity capital, attracted by issuing common shares (additional shares)%;

  - Number of issued additional shares;

  - The amount of dividends paid per common share during the reporting period (or pay per unit of units) %;

  - The planned rate of dividend payments (interest on units), expressed as a decimal fraction;

  - The amount of equity raised by issuing common shares (additional shares);

  - Cost of share issue, expressed in fractions of a unit with respect to the amount of issue of shares (additional shares).

The index of average cost of equity is determined by taking into account the valuation of individual constituent elements of equity and the share of each of these elements of the-ing its amount.

Cost of debt

Borrowing in the financial management estimated ¬  is called for elements:

• The cost of financial credit (banking and leasing);

• The cost of capital, attracted by issuing bonds;

• The cost of commercial credit provided in the form of short or long delay of payment;

• Cost of current commitments on settlements.

The cost of financial credit is valued according to the main sources of its provision - the bank credit and financial leasing.

The cost of bank credit is determined based on the interest rate for the loan, which forms the major cost of its servicing ¬ Niya. The rate of interest in the evaluation process should be adjusted according to two clarifications:

• Rate should be increased to the size of other basic and additional elements of payment for a loan, which are due to contractual terms, such as credit insurance by the borrower, the fee for performing certain operations, etc.;

• Rate should be reduced by the tax rate on profits as payment for the loan include the cost of products and services company, thus lead to a decrease in the tax base of profit and provide savings on income tax on the amount of interest payments for the use of credit resources.

Consequently, the cost of debt capital raised in the form of bank credit, can be determined by the formula

                             , ,

Where - the cost of debt capital attracted in the form of bank credit;

  - The interest rate for bank loans;

  - The rate of interest on income tax, expressed as a decimal fraction;

  - The level of costs to attract bank credit, expressed as a fraction of unity.

The cost of financial leasing. The basis for determining the value of capital raised in turn by using leasing as a form of financing is the rate of lease payments or the leasing rate. Leasing rate includes two elements:

• repayment of the principal, expressed annual rate of depreciation of financial assets, raised under a finance lease, on which after the expiration of the lease agreement the asset becomes the property of the lessee;

• The cost of servicing the leasing debt.

 

Then the cost of capital raised under a finance lease can be determined by the formula

                          , ,

Where - the cost of capital, attracted by the financial leasing;

LS - the annual leasing rate,%;

AT - annual rate of depreciation of the asset, attracted by financial leasing,%;

SNP - income tax rate, expressed as a decimal fraction;

ZPfl - the level of costs to attract assets under capital lease to the value of this asset, expressed as a decimal fraction.

Raising capital under capital lease should be taken into account as a criterion for the effectiveness of the following:

• The cost of the lease shall not exceed the cost of bank credit for the same period;

• The cost of finance lease should be maximally reduced.

Cost of debt, leverage, through the bond issue. The basis of valuation of capital is called the coupon rate of interest on bonds, which allows you to determine the amount of the periodic coupon payments. In these circumstances, the cost of capital, defined by

                               ,

Where Sozka - the cost of capital, attracted by issuing bonds,%;

SK - coupon bond interest,%;

SNP - income tax rate, expressed as a decimal fraction;

Ezo - the level of emission costs on the volume of emissions, expressed as a decimal fraction.

If the sale of bonds is accompanied by other conditions, the base assessment is the total amount of discount on bonds payable at maturity of the bond. In this case, the cost of borrowed capital is determined by the formula

,

Where COC  - cost of capital, who has been called by issuing bonds,%;

Dg - the average annual amount of the discount on bonds;

But - nominal bonds maturing;

SNP - income tax rate, expressed as a decimal fraction;

Ezo - the level of emission costs in relation to the amount of emissions, expressed as a decimal fraction.

The cost of commercial trade credit is evaluated differently depending on the conditions of its provision:

• under short-term deferral of payment;

• on long-term deferred payment.

In the first case, the cost of capital may seem like a zero value, since in practice the delay in payment for products delivered within the stipulated period of one month does not involve additional charges. Outwardly, this form of the loan looks free. However, such loans are usually accompanied by alternative terms of payment: if the buyer under the contract uses the delay in payment within a month from the date of delivery (receipt) of the product, then it loses the discount for cash payment (discount cash discount), which reaches 5% . In this case discount advocates a form of payment for use of loan capital, borrowed under a short-term commercial credit. As per the annual period of time the cost of capital has been increasing, which leads to what at first glance, free source of funding actually becomes the most expensive. The cost of commercial credit, raised under a short-term deferral of payment may be determined by the formula

,

,

Where STKk - the cost of commercial credit provided under short-term deferral of payment,%;

CA - price discounts offered under the terms of payment against documents,%;

SNP - income tax rate, expressed as a decimal fraction;

ON - period deferment of payment for goods, days.

Hidden nature of the cost of commercial credit, involved in short-term conditions, makes the treat very carefully to the name of the source of funding. Since in each case the calculations may lead to different results. Depending on the payment terms offered by a supplier, you may find that using a bank loan to finance the company's management will be more profitable, since it would have effect for payments in cash based on the use discount cash discount.

The cost of commercial loans raised in the form of long-term deferred payment with registration of the instrument. Assumptions for calculation in this case relate to the terms set out for a bank loan. However, it remains relevant loss account for the calculation of price discounts on deliveries under the cash payment.

Thus, the value of commercial loans, raised on long-term deferral, calculated as

,

,

Where the ETS - the cost of commercial credit in the form of long-term deferred payment with registration of the instrument, %;

CPR - the interest rate for a bill credit, %;

SNP - tax profit, expressed as a decimal fraction;

CA - discount cash discount wireless provider, expressed as a decimal fraction.

Value of current liabilities of the company estimated. In calculating the cost of debt capital, this kind of financial resources takes into account the zero rates as a free finance ion of the company. The amount of these obligations conditionally equivalent to equity capital when calculating standard Working capital. In other cases, this part of the ongoing obligations treated as loan capital raised within a month. Terms of calculations on the above category of obligations secured regulatory, this also applies to payments of wages and payments for taxes, insurance and other elements, for this reason that this type of debt is almost not affected by optimizing the management cost of capital, as well as its quantity.

The value of individual elements of equity and debt allow us to determine the weighted average cost of capital.

Evaluation of weighted average cost of capital

For the final evaluation of the weighted average cost of capital is important to determine the specific gravity of each element of the total capital of the company. Then the weighted average cost of capital can be calculated by the formula

  ,

,

Where CCK - weighted average cost of capital, %;

Ci - the cost of a particular element of the company's capital, %;

Yi - share a particular element of the company's capital in its total amount.

Weighted average cost of capital is an important parameter for evaluating the effectiveness of financial management processes of capital formation.

4. Calculation part

4.1. Calculation and analysis of activity ratios

Business activity in the financial aspect is manifested primarily in the rate of turnover funds.

Coefficient of total capital turnover (resursootdacha).

K1 = (Sales) / (period average total balance - Loss)

Reflects the turnover rate (the number of revolutions per period) of the total capital.

K199 = 106 / 168.6 = 0.629

K12000 = 277.4 / 320.2 = 0.866

For 2000 we are seeing an increase in circulation of PC “Embamunaygeofizika”. Number of revolutions of 2000 increased from 0.629 to 0.866 annual turnover.

Turnover ratio of mobile assets.

K2 = (Sales) / Current assets

Ratio shows the rate of turnover of working capital.

K299 = 106 / 168.6 = 0.629

K22000 = 277.4 / 320.2 = 0.866

For 2000 we are seeing an increase in circuit current assets of PC “Embamunaygeofizika”. Number of revolutions of 2000 increased from 0.629 to 0.866 annual turnover.

Stock turnover (means).

K3 = (Sales) / stocks

Ratio indicates the number of revolutions of reserves and expenses for the period analyzed.

K399 = 106 / 32.4 = 3.27

K32000 = 277.4 / 38.9 = 7.13

For 2000 we are seeing an increase in cycle inventory (assets) PC “Embamunaygeofizika”. Number of revolutions of 2000 increased from 3.27 to 7.13 turnover per year.

Turnover ratio of cash.

K4 = (Sales) / Cash

Ratio shows the rate of turnover of money.

K499 = 106 / 0.9 = 117.8

K42000 = 277.4 / 0.2 = 1 387

For 2000 we are seeing an increase in the rate of turnover of money PC “Embamunaygeofizika”. Number of revolutions of 2000 increased from 117.8 to 1387 turnover in the year.

Turnover ratio of receivables.

K5 = (Sales) / (Average for the period of accounts receivable)

Coefficient shows an increase or decrease in commercial loan from the organization.

K599 = 106 / 97.5 = 1.09

K52000 = 277.4 / 121.2 = 2.29

For 2000 we are seeing an increase in commercial loan from the organization.

For 2000 we are seeing an increase in accounts receivable cycle PC “Embamunaygeofizika”. Number of revolutions of 2000 increased from 1.09 to 2.29 turnover per year.

Term receivables turnover.

K6 = (360 days) / (K5)

Coefficient shows the average maturity of accounts receivable.

K699 = 360 / 1.09 = 330.3

K62000 = 360 / 2.29 = 157.2

For 2000 we have seen reduction in the average maturity of receivables of the enterprise.

Turnover ratio of accounts payable.

K7 = (Sales) / (Payables)

Coefficient shows an increase or decrease in commercial loan from the organization.

K799 = 106 / 118.5 = 0.895

K72000 = 277.4 / 231.5 = 1.2

For 2000 we are seeing an increase in the rate of payment of arrears.

Term accounts payable turnover.

K8 = (360 days) / (K7)

Coefficient shows the average maturity of accounts receivable.

K899 = 360 / 0.895 = 402.2

K82000 = 360 / 1,2 = 300

For 2000 we have seen reduction in the average maturity of payables PC “Embamunaygeofizika”.

Turnover ratio of equity capital.

C9 = (Sales) / (Capital and Reserves)

Ratio shows the rate of turnover of equity.

K999 = 106 / 48.8 = 2.17

K92000 = 277.4 / 36.3 = 7.65

For 2000 we are seeing an increase in the rate of turnover of equity.

Return on assets.

C9 = (Sales) / (Fixed Assets)

Capital productivity shows the efficiency of fixed assets of the enterprise.

K999 = 106 / 97 = 1.09

K92000 = 277.4 / 155.4 = 1.79

In 2000, witnessing an increase in return on assets on equity of PC “Embamunaygeofizika” from 1.09 to 1.79.

Efficient use of capital stock measure of capital productivity indicators and capital ratio. Capital productivity of assets by the ratio of revenue from product sales to the average value of fixed assets