How can you adjust the net present value analysis to compensate for the inclusion of the interest expense?
Financing Charges and Net Present Value
The president of the company is not convinced that the interest expense should be excluded from the calculation of the net present value. He points out that, "Interest is a cash flow. You are supposed to discount cash flows. We borrowed money to completely finance this project. Why not discount interest expenditures?" The president is so convinced that he asks you, the controller, to calculate the net present value including the interest expense.
Many possible ways exist for examining this problem. From a theoretical perspective, of course, interest expense (like dividends) is excluded because it is captured in the discount rate.
But here is another way of viewing an investment. An investment that is entirely debt-financed is a positive NPV project if, at the end of the project, there is excess cash after paying the interest and the principal of the debt. This can be seen in the following equation where early cash flows are re-invested at a rate "r" to pay off the principal of the loan at the end of n periods, which is also the length of the project.
(CF1)(1 + r)n-1 + (CF2)(1 + r)n-2 + .... + (CFn) > or < Investment (= Principal)
where CFi = Cash flows in period i including interest payments.
If the left hand side of the equation is greater than the right hand side of the equation, the investment has a positive NPV and is acceptable. This analysis assumes complete debt financing to capture all of the opportunity cost of using cash.
You might also like to view...
In order to determine customer needs and to implement marketing strategies and programs aimed at satisfying those needs, marketing managers need information about ________
A) customers B) competitors C) other forces in the marketplace D) all of the above
________ and ________ do not take title to goods, and they perform only a few channel functions
A) Full-service wholesalers; limited-service wholesalers B) Brokers; agents C) Industrial distributors; cash-and-carry wholesalers D) Cash-and-carry wholesalers; industrial distributors E) Rack jobbers; off-price retailers
The intangible nature of services requires service firms to use indirect distribution over direct distribution or franchising
Indicate whether the statement is true or false a. True b. False
A major problem with sending instant messages to people is that the message
A) usually only makes sense to tech-savvy workers. B) gives the impression of the sender being disorganized. C) can be quite disruptive to the other person. D) is typically in violation of company policy.