Cost of Capital (CoC)

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 to the owners of the system. The cost of capital is often a 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 for instance small scale independent water providers have to recover the cost of 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 ) 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.