Balanced average costs of the capital

The average costs balanced of the capital (CMPC or WACC in English) is the awaited average rate of profitability annual, by the shareholders and the creditors, in return of their investment. It measures what the company owes with all those which brought capital to him. For the company, it is a help with the choice of the way of financing; for the associates, it brings information on opportunity of investing in a company; for the creditors, it is a measurement of the risk which they take by making credit with a company.

Utility to determine the CMPC

A company has three principal funding sources:
- its associated which brings stockholders' equity ;
- the third (various banks, financial institutions, lenders) which bring capital external in the form of loans and of debts that the company will have to refund;
- the self-financing , primarily composed of the result not distributed of its last activity (benefit of the previous years).

The two first represent a source of capital often more interesting than the third, limited in its amount and available in a dubious way, since it depends on the results of the activity.

From the point of view of the company

When she seeks new financings, she will address herself to her associates or lenders. One of the questions which it installation is to compare the cost of its funding sources to call upon the least expensive source. The CMCP will be used to him as indicator of reference.

From the point of view of associated the

The cost of the stockholders' equity is often compared to the output awaited by the owners (associated in the case of a company whose capital is divided into partnership shares) expressed as a percentage. It is thus related to their Opportunity cost, in other words the output of the similar placements which they can make.

From the point of view of the creditors

The cost of the financial debts is equivalent to the interest required by the lenders.

Calculation

On the assumption of a universe without tax, the cost of the capital is the Weighted average by the value of market of the debts and equities of the two costs.

Example:
That is to say a company whose capital is composed to 60% of equities and 40% of financial debts (in value of market). If the output required by the shareholders is of 9% and the interest of the loan of 6%, then the cost of the capital is of 9% X 60% + 6% X 40% = 7,80%.

By taking account of the tax, the balanced average costs of capital (CMPC, or English WACC for Weighted Average Cost off Capital ) is defined mathematically as follows:

$CMPC = (E/V) *kE + (D/V) *kD* (1-t)$

where:

E: equities;
D: foreign funds;
V: value total of the company, is E + D;
kE: cost of equities;
kD: cost of the foreign funds;
T: income tax rate;

By taking again the example above, under assumption of T = 30% one have

9% X 60% + 6% X 40% X (1-0.3) = 0.0708 are 7.08%

It is observed that the value of the CMPC is lower than 7.8%, which is explained by the fact why the load of interest generated by kD is fiscally deductible. This model finds nevertheless its limits in the costs of financial distresses which occur as the debt becomes a heavy burden for the company.

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