Cost of capital

Capital refers to the sources of corporate funds (liabilities of the balance sheet), which generate revenue. These sources are means of well-being of the owners of the enterprise in the actual and forthcoming period. Sources of corporate financing are one of the main criteria that determine the value of business. Some of them have an impact on the amount of net active assets of the enterprise.

The cost of capital reflects the amount of money that should be given (pay) for attracting a certain amount from sources of corporate funds.

As you know, the company has various sources of financing. Each of them has its own price.

For example, the value of the firm's equity is formed from the amount of dividends on shares (in the case of equity capital) or from the amount of profit paid on shares and expenses associated with them.

An enterprise can attract borrowed funds. In this case, their price is composed of the amount of interest paid on the loan or bonded loan, as well as the costs associated with them.

As a source of financing, an enterprise can use the funds raised. In this case, the cost of capital (accounts payable) is the amount of penalties for accounts payable, not repaid in a period exceeding three months from the date of its occurrence, or within the time period stipulated in the contract (contract).

Each enterprise has its own financial structure, consisting of various sources of cash. When evaluating attracted funds, the concept is used, such as the weighted average cost of capital. It combines the prices of all monetary sources.

It should be noted that the concept of "cost of capital" can be interpreted in different ways. When assessing the investments of managers, the marginal, marginal price of corporate funds is more interested. In connection with the fact that the cost of capital is the weighted average price of various components that make up the financial structure of the organization, it is often called marginal.

If in the financial system of the enterprise there are certain types of securities, then their price should be calculated separately and weighed taking into account the share that accounts for these securities in the total volume of corporate funds.

Before determining the weighted average cost, long-term sources of finance are determined, the formation of the price of attraction of sources and their market value.

The main sources of long-term financing include bonds, loans, preferred and common shares.

The price of these sources is compiled on the basis of dividends paid on shares, as well as in accordance with interest on the loan. Interest is reflected in reports on the results of financial and economic activities and (in contrast to dividends) are included in the cost price. This is called "anti-tax effect." Due to this, credit is usually cheaper than attracting finance through the issuance of shares.

The price of corporate funds raised by the issue of shares for companies that are included in the official list of quotations of the stock exchange will depend on the level of dividends, placement and issue prices, as well as the market value of shares.

The share for each source of funds in the total amount of all attracted funds is determined in accordance with the price of placement and issue of shares, but not at their nominal value.

Thus, the weighted average cost of corporate funds is influenced by the share of each source of financing.