Difference between revisions of "Cost of Capital (CoC)"

Revision as of 02:03, 17 May 2014

The cost of capital is the financial cost of borrowing money to provide and maintain assets for water, sanitation and hygiene services. It is made up of the interest paid on borrowed money plus any returns on equity to the owners of the system. The cost of capital is often given as the percentage (%) over the loan amount. Typical loans that private individuals get at a bank range from 5 –30 % per year.

For example where microfinance is used to support household sanitation, there is an interest cost attached to the borrowing. Or when small-scale independent water providers have to take a loan from a bank in order to pay for drilling a borehole and building an overhead tank. The cost of the interest on a loan is the cost of capital. This is usually added to the daily rent that water carriers, carters, or tanker operators pay to the owners of their carts or tankers. Such small-scale enterprises also need to make enough profit to cover the cost of their own capital invested, in addition to the interest they pay on loans. The cost of capital may not be apparent to customers as it is wrapped up in the overall charge.

If a system is financed through a grant, then there is no cost of capital, but if a government borrows to fund a water and sanitation programme, there is a cost of capital to the government.

Examples

Even subsidised loans with interest rates lower than 1% can lead to significant annual expenditures on cost of capital if there is a large loan and a long repayment period as shown by the example of Franceys, Naafs, Pezon and Fonseca, 2011:

A governmental body borrows US$ 22 million from a development bank to improve the water and sanitation situation for around a million people. The loan was for a 50-year period. It was agreed that for the first 10 years, from 2013 to 2023, no repayment of principal would take place.

The development bank charged a fee of 0.5% per year for money that had been allocated and reserved but not yet used (known as a commitment charge (*) that is charged annually on funds not yet disbursed to the project) and 0.75% in interest (**) for the money that the project was already spending. The repayment of the principal, starting in year 10, is 1% for 10 years and 3% over the final 30 years.

In this example the annual cost of capital is averaging approximately US$ 100,000 per year with total commitment and interest payments over the period of approximately US$ 4,900,000. In order to be able to repay both the cost of capital and the original loan, the government has to plan for the total annual cash flow payments shown in Figure 1.

(*) Commitment charge percentage is charged yearly on the funds that have not yet been disbursed to the project.

(**) Interest percentage is charged on funds that have been disbursed to the project.

Figure 1. Yearly interest payments and principal repayment

Source: Franceys, Naafs, Pezon and Fonseca, 2011

As most water and sanitation infrastructure does not have a life span of more than 20 or 30 years. The financial burden of paying the cost of capital often surpasses the life span of the infrastructure it financed. In this example the government is paying the cost of capital for 50 years while the water or sanitations systems that were constructed with the loan probably need to be replaced or rehabilitated after 10 – 30 years.

Key documents

• Franceys, R., Naafs, A., Pezon, C. and Fonseca, C., 2011. The cost of capital : costs of financing capital expenditure for water and sanitation. (WASHCost briefing note; no. 1c). The Hague, The Netherlands: IRC International Water and Sanitation Centre.

This 20-page briefing note investigates the cost of financing capital expenditure, usually referred to as the cost of capital. It explains why it is one of the life cycle cost components that make up the total costs of providing water and sanitation services that last.

• Naafs, A. and Rousseau, K., 2011. Finance and cost of capital: an additional cost made visible. (WASHCost information sheet; MOZ F-01). [online] The Hague, The Netherlands: IRC International Water and Sanitation Centre.

This Information sheet opens the discussion on Cost of Capital. How much is the sector (indirectly) paying for interventions in the past and how much is the sector planning to pay in the future?

Links

• WASHCost was five-year action research programme, running from 2008 to 2012. The WASHCost team gathered information related to the costs of providing water, sanitation, and hygiene services for an entire life-cycle of a service - from implementation all the way to post-construction. The WASHCost programme was led by IRC International Water and Sanitation Centre with several partners to collect data in the rural and peri-urban areas of Burkina Faso, Ghana, India, and Mozambique. For more information see WASHCost

• The Costing Sustainable Services online course was developed to assist governments, NGOs, donors and individuals to plan and budget for sustainable and equitable WASH services, using a life-cycle cost approach. The Life-cycle cost approach is a methodology for costing sustainable water, sanitation and hygiene service delivery and comparing the costs to the level of service received by users. For more information see WASHCost Online Training

• WASHCost data sets provide access to the validated life-cycle cost and service level information collected in Burkina Faso, Ghana, Andhra Pradesh (India), and Mozambique between 2009 2010. The data has been collated from a number of sources including infrastructure surveys, detailed household surveys and range of specific research undertaken with stakeholders in each country. The data sets are available at washcost.info/page/2716

• Triple-S (Sustainable Services at Scale) is a six-year, multi-country learning initiative to improve water supply to the rural poor. It is led by IRC International Water and Sanitation Centre. The initiative is currently operating in Ghana and Uganda. Lessons learned from work in countries feeds up to the international level where Triple-S is promoting a re-appraisal of how development assistance to the rural water supply sector is designed and implemented. For more information see Water Services That Last