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John Moffat.
John Moffat.-
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AverageAndy
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Hello John Sir,
hope you’re doing good.sir when doing NPV computations i understand that we do not deduct actual interest payments or principal repayment from our net cash flows as the interest payments are already considered within the discount factor which you briefly mention in one your lectures. However, could you clarify as to how both interest payment and specifically principal repayment are factored in?
It’s as if i know the fact, but not the premise withstanding it.
Your help would be much appreciated!
John Moffat
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The sole purpose of discounting is to see if the return from the project in which we invest is greater than the interest we are having to pay on the loan.
If you borrow $10,000 to invest in a project then we will have to repay $10,000 at some time in the future. We do not show the repayment as a cash outflow just as we don’t show the initial borrowing as a cash inflow.
The only cost involved in borrowing money is the interest that has to be paid on the borrowing. The interest cost is included in the calculation of the WACC and we discount at the WACC in order to account for the cost of money. If we included the interest payments in the cash flows then we would be accounting for the interest twice.
AverageAndy
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