Hi, I’m a level two candidate but I feel like I need some real expertise and work experience for this question. And I appreciate your help!
I’m having some real trouble understanding two principal in capital budgeting
- Cashflows are based on opportunity cost.
- Interest expense is excluded from cashflow, otherwise, we would be double counting.
Can someone give me an example of an opportunity cost that should be included in real life? I’m thinking along the lines of, if have 100k and undertake project A, what I’m missing out on project B should be included as an outflow for my cashflow assumption?
My bigger trouble is with the interest expense being ignored… I mean holy cow. Let’s say I burrowed 100K interest-only loan from the bank at 10% for my real estate investment. Do I exclude the 10K I pay out in interest every year? If this is the case, all the NPV and IRR analysis I’m doing for my job are all incorrect, and I work for a publically traded REIT firm and they gave us the model. My second thought is that maybe this concept is referring to implicit interest cost at 10% should not be included.
I would appreciate it if someone can give me a response on this. Thanks!