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Dear John, thanks for all your answers.
to repeat all of MA and FM lectures for AFM would be ridiculous => I did watch your MA lectures and actually referred to them (not AFM) in my previous comment (because you referred to them in your original comment:)
When you invest the 100,000 in a project you therefore have to make sure that the returns from the project are sufficient to cover the interest cost => if you take a loan to implement a project, I think your primary concern is not so much the interest, but actually the principal repayment (as it is much more money and often specific time you need to do it), which is not reflected in the classic model
However the loan is repaid, then the PV of the repayments will always be equal to the amount of the original loan => this assumes there will be cash available to repay the loan on loan agreement specified dates, which in reality may or may not be true, and that is one of the biggest deficiencies of the classic model, I think
PV of the repayments will always be equal to the amount of the original loan => how are loan/repayments different from additional working capital requirements at the beginning/full return at the end?
Gentlemen, thank you for your quick answers, despite one of them being not in a relevant section (…talking about relevant things…:) I hope you don’t mind me giving this topic another spin.
As for the interest, this is clear to me, it is already included into the WACC or discounting rate etc. Good, let’s leave this behind. My question is about a loan and its repayment installments.
@adamliew: I am not sure the fact that a loan is supposed to be repaid could be an explanation, following this logic working capital should not be a relevant cash flow either. It is also fully returned at the end of the project (well, so we are told by the book).
@John: you mention that a loan and its repayment are not relevant cash flows, but why? I have watched your lectures but regretfully couldn’t find a section dealing with my question.a) if I plan to repay a loan from my project cash flows, I believe it is more than relevant to include these cash flows into the project assessment to see how the whole thing stacks up.
b) also, as related examples are usually something like “we want to buy another machine that will produce X items that will sell at Y price…” it is difficult to imagine project cash flows as something separate from general company cash flows. But let’s imagine for a second that we set up a separate legal entity to complete a capital project, which is not unusual for big projects, and we get a loan to start our project. Our (project’s) first cash flow transaction is not buying a machine, but actually getting cash into our account, so why is it excluded from the classic project evaluation methodology?
My only personal explanation I can loosely connect to the absence of loan/repayment cash flows is that after I have taken a loan, speaking generally, it becomes part of a total company cash pool, so it is kind of difficult to finger point which pound is for a particular investment project and which one is for settling accounts payable. So, this becomes a treasurer’s headache how and when we repay this loan while the project assessment in its pure form excludes these details. I can’t say it is very convincing but this is the best I can think about.
I apologize for my wordiness today.
