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Hi
I was wondering – If the loan principal does not have to be repaid at all then why is this not considered in the calculation at all?Kind regards
Dennis98They will still have to pay interest and therefore get the tax benefit on the interest.
Dear John,
I have the same question: I understand that tax shield should be calculated because interest is tax deductible, but because the entire project is financed with loan which is received by government and government does not require Tramont to repay principal this effectively means that Tramont is not using its own cash and initial outflow at investment stage is 0. However in the answer investment is stated to be 230 GR. Could you please help me understand this detail, I am rather confused.
But whether or not they repay the loan the will have to keep paying interest on it.
Therefore the project has to generate enough cash on the whole amount invested in order to cover the amount required by shareholders together with the interest payable on the loan.
Forgetting this particular question and everything to do with APV, usually we appraise a project by discounting at the WACC. The WACC itself is a combination of the cost of the equity finance and the cost of the debt finance, and is the cost of the entire investment – even if the debt borrowing is irredeemable debt and therefore not repayable.
The discounting is to check that the project gives enough returns to cover all the costs of raising the money needed for the investment.
I don’t have a problem with the interest being included, that’s fine. What I’m wondering is how can it be ignored that we don’t have to repay the principal, surely that means that the initial outlay in year 0 of GR270 million shouldn’t be included as a cost at all?
Yes it should – I don’t think that you have read my previous reply properly.
The whole point of discounting (whether APV or not) is to check that the investment is generating more than the cost of the money invested.
The cost of the money invested has nothing to do with whether the borrowing is going to be repaid or not (money borrrowed from shareholders is not going to be repaid).
All of the money invested is being borrowed (whether from shareholders or from borrowings or both). Shareholders need a return on the amount they provide, lenders get interest on the amount they provide. One way or another all the money invested will cost the company to finance each year.
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