Review of Commonwealth Government Business Enterprises ...

4.2A Weighted Average Cost of Capital
4.2.2 Paragraphs 4.9 and 4.10 of the current GBE Guidelines require that GBEs classifed as
trading GBEs should use the Weighted Average Cost of Capital (WACC) as their principal
fnancial target as recommended by the ANAO 43 and accepted by government. The WACC
target is designed to encourage businesses to target returns suffcient to justify the assets
used in the business and cover the cost of capital employed.
4.2.3 More specifcally, the WACC requires that returns are suffcient to cover the cost of debt and
the cost of equity, which is generally estimated via the capital asset pricing model (CAPM).
4.2.4 Finance considers that the WACC remains a useful fnancial target for most GBEs.
However, for GBEs that are service-based and carry little or no debt as part of their optimal
capital structure (such as the Australian Government Solicitor), the WACC will essentially
be the cost of equity calculation. This is because the cost of debt calculation will be zero
where there are no borrowings or very low where the GBE has limited borrowings.
4.2.5 For newly established GBEs and for GBEs that are in the process of being wound up,
it may be appropriate to target the achievement of relevant principal and other fnancial
targets over the medium term. Nevertheless, establishing appropriate fnancial targets in
consultation with the Shareholder Minister(s) on an annual basis is required to drive the
decisions of the GBE.
4.2.6 The current GBE Guidelines defne adding to shareholder value as where the return on
assets (ROA) is increased. However, the ROA does not necessarily refect shareholder
value. Rather, the ROA is used to determine the effciency of the business i.e. the return
generated from the assets held.
4.2.7 Finance therefore proposes that reference to the ROA be removed and that the revised
GBE Guidelines defne adding to shareholder value in the context of meeting or exceeding
the fnancial targets agreed with the Shareholder Minister(s) including the principal fnancial
target related to WACC.
4.2.8 Other performance measures remain important and the revised GBE Guidelines will
continue to provide scope for GBEs and the Shareholder Minister(s) to discuss additional
fnancial targets and measures. This will continue to promote a more robust and holistic
approach to determining GBE performance.
Proposed Change:
Financial Targets for GBEs
4.13 4.7 All GBEs are required to add to shareholder value in their operations with a view to
at least meeting the fnancial targets agreed by the Shareholder Minister(s) in the
annual corporate plan.
a. Increases in shareholder value are achieved when the return on assists is increased
GBE’s weighted average cost of capital (WACC) is exceeded, regardless of whether
or not the target return is reached. However where a GBE achieves a return which is
less than its fnancial target, it has not achieved the minimum return acceptable to the
shareholder, and the shareholder would expect the adoption of strategies aimed at
achieving the target.
Exposure Draft
43 Australian National Audit Offce in Report No. 15, 2000-2001, Agencies’ Performance Monitoring of Commonwealth Government Business Enterprises,
refer to http://www.anao.gov.au/uploads/documents/2000-01_Audit_Report_15.pdf
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