Hi john in real life when borrowing say for 5 years the total interest rate in figures overall for the 5 years will be higher than if i was borrowing for say 9 months but for yearly do they charge a higher percentage for interest rate yearly if i was borrowing for 5 years against if i was borrowing for 9 months which one would be higher 5 years or 9 months on a yearly bases

It depends on various factors, such as what the lender expects will happen to general interest rates in the future, what security is offered, and the credit worthiness of the borrower.

Hi John Based on your answers above is it safe to assume for F9 that interest payments are only deducted when calculating WACC for Debt. Everywhere else interest payments are ignored and interest rate % is only used for Discount.

I don’t know what you mean by ‘deducted when calculating WACC for debt’!

We never deduct interest payments when arriving at the cash flows each year, because this is accounted for in the discounting. The calculation of the WACC includes the cost of both the equity and the debt finance.

Hello John I see your reply in respect od interests but I still can’t explain it to myself why don’t we include interests in the cash flow and would do it twice if we do that… Interests will be pay out by the company , we will incurr these costs out of the company’s bank account, so they seem to me to be relevant.

I base my understanding on the debt valuation, where we do include interests and associated Costs and repayments, we then discount them using cost od debt coming to npv of the future cash flows = market value.

I am Aware that my understanding is wrong but don’t know why…

The reason for discounting projects is to account for the cost of the money – there is no other reason for doing it.

When calculating the WACC we include the cost of the debt interest in the calculations, so this is what I mean by saying that when we discount at the WACC we are taking account of the interest.

As far as the exam itself is concerned, then accept it as a rule. However if you are still not convinced, then in the discounting lectures for Paper F2, I go through some very simple examples to explain this.

Is there a reason why we didn’t use the annuity table to calculate for the lease payments? If we can use it…will we use it for 5 years as the first payment is made at the start of the year? I get $635,500 for the lease payment using 4.100. It’s a big difference if I am correct in my calculations.

I just read the answers PDF after trying to figure it out for some time by myself. Sorry. I should have looked there first. Happy New Year. I hope you have a great 1!

The purpose of discounting is to account for the interest. If we included the interest in the cash flows we would effectively be dealing with it twice.

Hi John, I’ve still confused why the interest payment for the borrowing is not a relevant cost. Could you pls give me some more clarification? Many thanks! Gillian

natty2 says

Hi john in real life when borrowing say for 5 years the total interest rate in figures overall for the 5 years will be higher than if i was borrowing for say 9 months but for yearly do they charge a higher percentage for interest rate yearly if i was borrowing for 5 years against if i was borrowing for 9 months which one would be higher 5 years or 9 months on a yearly bases

John Moffat says

It depends on various factors, such as what the lender expects will happen to general interest rates in the future, what security is offered, and the credit worthiness of the borrower.

umerr786 says

Hi John

Based on your answers above is it safe to assume for F9 that interest payments are only deducted when calculating WACC for Debt. Everywhere else interest payments are ignored and interest rate % is only used for Discount.

Thanks

John Moffat says

I don’t know what you mean by ‘deducted when calculating WACC for debt’!

We never deduct interest payments when arriving at the cash flows each year, because this is accounted for in the discounting. The calculation of the WACC includes the cost of both the equity and the debt finance.

Tomasz says

Hello John

I see your reply in respect od interests but I still can’t explain it to myself why don’t we include interests in the cash flow and would do it twice if we do that…

Interests will be pay out by the company , we will incurr these costs out of the company’s bank account, so they seem to me to be relevant.

I base my understanding on the debt valuation, where we do include interests and associated Costs and repayments, we then discount them using cost od debt coming to npv of the future cash flows = market value.

I am Aware that my understanding is wrong but don’t know why…

Regards,

Tomasz

John Moffat says

The reason for discounting projects is to account for the cost of the money – there is no other reason for doing it.

When calculating the WACC we include the cost of the debt interest in the calculations, so this is what I mean by saying that when we discount at the WACC we are taking account of the interest.

As far as the exam itself is concerned, then accept it as a rule. However if you are still not convinced, then in the discounting lectures for Paper F2, I go through some very simple examples to explain this.

DreamerSK says

Hello John,

Is there a reason why we didn’t use the annuity table to calculate for the lease payments? If we can use it…will we use it for 5 years as the first payment is made at the start of the year? I get $635,500 for the lease payment using 4.100. It’s a big difference if I am correct in my calculations.

Thanks.

DreamerSK says

I just read the answers PDF after trying to figure it out for some time by myself. Sorry. I should have looked there first. Happy New Year. I hope you have a great 1!

DBakhriyeva says

Dear Sir,

Could you please advise, why we did not use interest payments in the caculations?

Diana

John Moffat says

Read my reply to the previous question (below).

John Moffat says

The purpose of discounting is to account for the interest.

If we included the interest in the cash flows we would effectively be dealing with it twice.

bohuahuang says

Thanks for your prompt reply! Like your lecture very much.

bohuahuang says

Hi John,

I’ve still confused why the interest payment for the borrowing is not a relevant cost. Could you pls give me some more clarification?

Many thanks!

Gillian