Average Cost of Several Sources

The cost of the company s own funds can thus be calculated, by means of the CAPM. However, it is an unusual company that does not have other sources of finance, each with its own cost (i.e. interest rates for different loans). The average cost of all of its sources of capital is expressed by a single figure, the weighted annual cost of capital ( WACC), calculated according to the relative amounts of each source of funds. 

Each source of finance is tabulated both with its effective cost and its proportion of the total amount of money in use. The product of the percentage cost and the (decimal) fraction share of the total funds gives the component of the final weighted cost for each source, as shown by the example in Table 2. 

The calculated WACC is a figure that changes with time, as a loan is paid off, or another taken out, or the proportion of company funds increases. Despite this changeability, the WACC provides a good benchmark against which to measure the rate of return on a new project, and it is precisely in this way that it is used later in this chapter. 

Source of funds Rate — cost (%) Proportion of total (%) Product = cost component 

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