Question

If the firm knows in advance that a project will be financed by a bank loan and that the cash flows from this project must cover the payments to the bank, would financing become a parameter in the capital budgeting decision? Why or why not?

Answer 1

Yes, it will become parameter in the capital bugeting decisions. In capital budgeting decisions, one needs to identify relevant cash flows. Relevant cash flows are those which occurs as result of undertaking the project, here interest payments are relevant cash flows as had company not decided to undertake the project, interest payments would not have occured.

Further cost of financing is also important. i.e at what rate of interest company is goingto finance the project. Normally this interest rate is used to discount future cash flows from the project and hence covers interest payments.