Hi All, having trouble understanding the calculation of interest expense when working towards accounting income in the Corp Finance realm. According to Schweser, interest expense in a given year is calculated as the beginning MV of the project (PV of remaining cash flows) x the loan interest rate. In the Topic Test “Scott,” question 2 asked for accounting income in year 2. “The equipment is to be financed entirely with a loan at 12%…” The answer did not use the above method of calculating interest expense for the year, but instead multiplied 12% times $300K, the initial capital investment… Can anybody walk me through this? Thanks very much!
Is the loan structured like a bond, i.e. pay coupon interest only every year and principal at end of project?
Yes sir!
Yes sir!
Accounting income is the Net Income from the Income Statement in my understanding. In this case you are given the EBIT, you calculate and deduct interest expense, and deduct tax and you got NI.
Right, but I’m trying to understand how the interest expense is calculated in this situation.
amount of loan taken out to finance the fixed assets of the project x interest rate
same for each year since it’s a bullet loan you repay the principal at maturity
Hmm that’s interesting and exactly what the solution said to do,so why would Schweser say to calculate interest expense as
(int rate) x (PV of remaining CFs)
I know I’m getting in the weeds on this, but still confused nonetheless. Appreciate your help on this!
Was this a specific question in Schweser? Or a thumb rule?
I might not be right but I think you are confusing 2 things:
Normally if a loan is amortized than you will calculate interest rate based on the loan amount at the beginningof the period x the interest rate.
And if you are not given the loan amount at the beginning of the period then you must calculate it as a PV of the remaining _ cash-flows of the loan _, but not as the PV of the remaining cash-flows of the project?
In our case the loan was not amortizing it was 300m each year.
I think you’re right, thanks very much. The problem in Schweser (Corp Finance, pgs 176-178) described a start-up company financed with 50% equity, 50% debt at 6%, and the company only expects to operate for the 4 year duration of the project. No loan value was given, so the interest expense in a given year was calculated as 50% of PV of remaining cash flows of the project, times 6%.