Question

Explain: When calculating property-level cash flows, you should utilize earnings before interest payments because on-going capital expenditures are roughly equal to depreciation allowances.

Answer 1

When we are calculating property level cash flows, we should be utilising earning before the interest payment because interest payment is a non operating type of expenditure and interest payments are reflecting the interest on various loans which are used for the different purposes and interest loan are never operational in nature so we will not be including the interest payments when we are calculating property level cash flows because property level cash flows is associated with the operating activities of the business and we should only utilise earning before interest payment in order to discount operating cost.

Ongoing capital expenditure are not equal to the depreciation allowance as ongoing capital expenditures are highly non uniform in nature whereas depreciation expenditure has a certain pattern to follow. Hence, we are not including the interest payment in overall property level cash flow that these payments are reflecting that they are non operating form of expenditures which are not to be included in the operating activities of the business whereas the depreciation is also related to non cash operating expenses, so DEPRECIATION is ALWAYS an OPERATING expense whereas INTEREST is NEVER an OPERATING expense so we will never include interest in property level cash flows