Question

Do you agree or disagree, and explain why. In each case, limit your answer to 100 words:

1. “When a company borrows to finance a project, the interest that it pays on the loan is an actual cash flow, not merely an accounting entry such as depreciation. In evaluating a project, it is therefore never correct to ignore debt interest, whether or not the company pays taxes”.

2. “Companies with low leverage and stable earns can borrow cheaply. As a result, these companies able to use a lower discount rate to evaluate investment projects and will place a higher value on them than companies with higher borrowing costs”.

Answer 1

Debt payment in the form of interest payment is generally not calculated when ascertaining operating income so interest payment is generally treated as non operating income and it is not calculated by determination of the cash flows from operating activities. But interest payment is generally payment which is associated with the business and it leads to out flow of income from the business enterprise and it will also cost The entity of financial distress so it should be recorded in overall profit recording of the company.

Companies with stable income can borrow with high leverage because it will help the company in gaining operational advantage because the company will be having regular cash flows to meet with the interest payments. Company with high borrowing cost will be having more interest cost and cost of financial distress because they do not have uniform cash payment to meet the interest obligation So this both statements are correct.