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sir can you please explain me the first point of this question and the solution as well of this first point.
1. An interest charge of 8% per annum on a proposed $50 million loan has been included in the project’s post taxcash flow before tax has been calculated.
solution
– Interest has been deducted and should be added back as this finance charge is properly charged through the application of the discount rate.as I cannt see in the question its mentioning that its charged through discount rate.
Thanks.
Interest payments should never ever be included in the cash flows.
The whole purpose of discounting is to account for the cost of money. We discount at the cost of capital which includes the cost of both equity and debt.
To include interest payments in the cash flows would effectively be accounting for it twice.
(The fact that the question doesn’t mention it is because it is always automatically the case.)
Sir sorry to bother you again please tell me why interest in june 09 your business interest is added in cash flow while december 09 kodiak company interest is deducted. Thanks
In June 2009 you are calculated the NPV of the project – we take the cash flows available for all investors (so before interest) and discount at the WACC.
In December 2009 the question asks for the ‘free cash flow to equity’ and so we take the cash flows available for equity (which are after interest) and discount at the cost of equity.
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