Appropriate model for deferred costs as a line-of-credit
There's no standard formula. You can compare the going rates on the market for unsecured LOCs and take that as the starting anchor. Unsecured lines of credit run in the US at about 8-18%. Your risk should be reflected in the rate, and I see no reason why the rate would change throughout the loan. As to the amount of principal changing? Just chose one of the standard compounding options - daily (most precise, but most tedious to calculate), monthly average balance, etc.
Im creating a 5-year projection on Profit and loss, cash flow and balance sheet and i\m suppose to use the LIBOR (5 year forward curve) as interest rate on debt.  This is the information i am given and it in USD.  Thanks for the link.  I guess its the USD LIBOR today, in one year, in two years, three years, four years and five years At the most basic level of financing a business -- you are trying to acquire capital as cheaply as you can to invest in your projects.  The measure for how expensive your capital is to acquire is Weighted Average Cost of Capital.    The formula for WACC:  Equity Ratio * Cost of Equity + Debt Ratio * Cost of Debt * (1 - Tax Rate) This is also your discount rate when you're making a DCF model.  Debt tends to be cheaper than equity when you don't already have any, and is also advantaged by tax rates since you don't pay taxes on interest.  In the real world, banks and lenders will ratchet up rates the more debt you acquire, or shut you out once you've taken on too much and your debt service coverage is too low for them.  In a classroom though, most teachers are too lazy to make a curvilinear formula for borrowing and will just state a rate for borrowing so you can load up on debt so long as you don't fall below being able to service your debt (cash flow to make your debt payments).  This will ultimately juice the returns on equity.  Realistically, you would find lenders would let you have ~20% equity in the business and ~80% debt without raising your teacher's eyebrow.  If you haven't taken accounting yet; be careful about the difference between cash and revenue in your analyses.  Revenue is recognition for work done; not cash in hand.  You can have all the revenue in the world but if no one's paid you for it yet, you can't pay anyone. "EBITDA is in my opinion not a useful measure for an investor looking to buy shares on the stock market. It is more useful for private businesses open to changing their structuring, or looking to sell significant parts of their business. One of the main benefits of reporting Earnings Before Interest, Taxes, Depreciation & Amortization, is that it presents the company as it would look to a potential buyer. Consider that net income, as a metric, includes interest costs, taxes, and depreciation.  Interest costs are (to put it simply) a result of multiplying a business's debt by its interest rate. If you own a business, and personally guarantee the loan that the company has with the bank, your interest rates might be artificially low. If you have a policy of reaching high debt levels relative to your equity, in order to achieve high 'financial leveraging', your interest cost might be artificially high. Either way, if I bought your business, my debt structure could be completely different, and therefore your interest costs are not particularly relevant to me, a potential buyer. Instead, I should attempt to anticipate what my own interest costs would be, under my plans for your business. Taxes are a result of many factors, including the corporate structure of the business. If you run your business as a sole proprietorship (ie: no corporation), but I want to buy it under my corporation, then my tax rates could look nothing like yours. Or if we operated in multiple jurisdictions. etc. etc. Instead of using your taxes as an estimate for mine, I should anticipate my taxes based on my plans for your business. Depreciation / amortization is a measure that estimates how much of a business's ""fixed assets"" were ""used up"" during the year. ie: how much wear and tear occurred on your fleet of trucks? It is generally calculated as a % of your overall asset value. It is a (very loose) proxy for the cash costs which will ultimately be incurred to make repairs/replacements. D&A is also something which could significantly change if a business changes hands. If the value of your building is much higher now than when you bought it, I will have higher D&A costs than you [because I will be recording a % of total costs higher than yours], and therefore I should forecast my own D&A. Removing these costs from Net Income is not particularly relevant for a casual stock investor, because these costs will not change when you buy shares. Whatever IBM's interest cost is, reflects the debt structuring policy that the company currently has. Therefore when you buy a share in IBM, you should consider the impact that interest has on net income. Similarly for taxes and D&A - they reflect costs to the business that impact the company's ability to pay you a dividend, and therefore you should look at net income, which includes those costs. Why would a business with 'good net income' and 'good EBITDA' report EBITDA? Because EBITDA will always be higher than net income. Why say $10M net income, when you could say $50M EBITDA? The fact is, it's easy to report, and is generally well understood - so why not report it, when it also makes you look better, from a purely ""big number = good"" perspective? I'm not sure that reporting EBITDA implies any sort of manipulative reporting, but it would seem that Warren Buffet feels this is a risk." Conservative = erring on the side of ascribing a higher EV to the business. Because if you're someone looking to acquire the business, for example, and let's say we're talking about a business that has debt which trades at a discount, it's more conservative to assume that the debt can't necessarily be restructured.  To use an extreme example, as you're valuing the business, would it be conservative or aggressive to assume that the debt got magically wiped out altogether? So that's why I'm saying that it's more conservative to use the book value of the debt. Hi guys, have a question from my uni finance course but I’m unsure how to treat the initial loan (as a bond, or a bill or other, and what the face value of the loan is).  I’ll post the question below, any help is appreciated.  “Hi guys, I have a difficult university finance question that’s really been stressing me out....  “The amount borrowed is $300 million and the term of the debt credit facility is six years from today  The facility requires minimum loan repayments of $9 million in each financial year except for the first year.  The nominal rate for this form of debt is 5%. This intestest rate is compounded monthly and is fixed from the date the facility was initiated.  Assume that a debt repayment of $10 million is payed on 31 August 2018 and $9million on April 30 2019. Following on monthly repayments of $9 million at the end of each month from May 31 2019 to June 30 2021.  Given this information determine the outstanding value of the debt credit facility on the maturity date.”  Can anyone help me out with the answer? I’ve been wracking my brain trying to decide if I treat it as a bond or a bill.”  Thanks in advance, "What you are describing is a Chart of Accounts.  It's a structure used by accountants to categorise accounts into sub-categories below the standard Asset/Liability/Income/Expense structure. The actual categories used will vary widely between different people and different companies.  Every person and company is different, whilst you may be happy to have a single expense account called ""Lunch"", I may want lots of expense accounts to distinguish between all the different restaurants I eat at regularly.  Companies will often change their chart of accounts over time as they decide they want to capture more (or less) detail on where a particular type of Expense is really being spent. All of this makes any attempt to create a standard (in the strict sense) rather futile.  I have worked at a few places where discussions about how to structure the chart of accounts and what referencing scheme to use can be surprisingly heated!  You'll have to come up with your own system, but I can provide a few common recommendations: If you're looking for some simple examples to get started with, most personal finance software (e.g. GnuCash) will offer to create an example chart of accounts when you first start a session." No, the more conservative approach is to use the market value of debt (at least assuming its trading at a discount). A company wouldn't necessarily have to come to an agreement with creditors, they would just default on their obligations. In which case the company may file for bankruptcy protection, which allows for a variety of scenarios to play out (both consensual and not).   As for when debt trades at a premium, we're talking about two different factors that effect bond prices. Credit risk and interest rate risk. But yes, a company does have a higher financial obligation if interest rates decline. They're stuck paying 8% in an environment where they could refinance for 6%. If they refinance, then creditors more than likely aren't going to take less than par. If they don't refinance, then they have the opportunity cost of essentially overpaying on their cost of debt. "Okay, yes! That would seem to make sense. So something like a Dupire local vol model.   In the context of term structure modelling, you can also incorporate a volatility surface into the pricing of European and even exotic options (e.g. through a SABR or an LMM-SABR for exotics), which I suppose means by your criteria there are actually varying degree of ""arbitrage free-ness"" when it comes to picking a model. By that I mean there are varying degrees of what your model takes as ""given"". If it takes the market price of risk as given, it's an equilibrium model. If it takes the observed term structure as given, it's an arbitrage free model. If it takes the volatility structure as given, it's something else.  Nawalkha, Beliaeva and Soto wrote a paper called ""A New Taxonomy of the Dynamic Term Structure Models"" in the Journal of Investment Management that basically coincides with what we're saying.  So yes, it sounds right to me." Are you trying to figure out if a project would increase the market value of equity?     I think your issue is that the Market value of Equity will not be updated with the NPV of 40M (Assuming it is truly +, not sure if it's true with 50M of debt).      EV = Market Value of Equity + Debt - Cash and CE   Ev - Debt + Cash and CE = Market equity value.     So I think you would have to update the market value of Equity up with 40M. This would then lead to EV = Equity Value + future income stream discounted + debt - Cash and Cash Equivalents. What you are looking here is the cost of capital, because that is what you are effectively giving up in order to invest in those loans. In a discounted cash-flow, it would be the *i* in the denominator (1+*i*). For instance, instead of purchasing those loans you could have lent your money at the risk-free rate (not 100% true, but typical assumption), and therefore you are taking a slight risk in those loans for a higher return.  There are several ways to compute that number, the one most often used would be the rate if the bank were to lend that money. In this way, it would be the Fed Funds rate plus some additional risk premium. "There are other good answers to the general point that the essence of what you're describing exists already, but I'd like to point out a separate flaw in your logic: Why add more complications so that ""should I call this principal or interest"" actually makes a difference? Why's the point (incentive) for this? The incentive is that using excess payments to credit payments due in the future rather than applying it to outstanding principal is more lucrative for the lender. Since it's more lucrative and there's no law against it most (all) lenders use it as the default setting." The short answer is that you would want to use the net inflow or net outflow, aka profit or loss.   In my experience, you've got a couple different uses for IRR and that may be driving the confusion.  Pretty much the same formula, but just coming at it from different angles.   Thinking about a stock or mutual fund investment, you could project a scenario with an up-front investment (net outflow) in the first period and then positive returns (dividends, then final sale proceeds, each a net inflow) in subsequent periods.  This is a model that more closely follows some of the logic you laid out. Thinking about a business project or investment, you tend to see more complicated and less smooth cashflows.  For example, you may have a large up-front capital expenditure in the first period, then have net profit (revenue less ongoing maintenance expense), then another large capital outlay, and so on.   In both cases you would want to base your analysis on the net inflow or net outflow in each period.  It just depends on the complexity of the cashflows trend as to whether you see a straightforward example (initial payment, then ongoing net inflows), or a less straightforward example with both inflows and outflows.   One other thing to note - you would only want to include those costs that are applicable to the project.  So you would not want to include the cost of overhead that would exist even if you did not undertake the project. "fair enough, but I wasn't sure if you actually get it or not because your question seemed to revolved around cash and transaction value.  You are really just said ""skewing"" is if you didn't add net debt the multiple wouldn't be a valid muliptle. If you understand it, why start out with this mental exercise of saying ""we shouldn't calculate multiples wrong, because then they would be wrong""?" Stop with all the stupid big words. You sound really pretentious. Just learn your 3 statements from accounting coach and learn statement analysis from streetofwalls.  If you're interested into valuation, streetofwalls is a good primer for DCF/public comps/M&amp;A comps/scenario analysis (LBO), but if you want to literally build out the model, Joshua Rosenbaum's investment banking valuation book is great. Everyone in banking I know used it to learn valuation "I'm assuming you're operating on the cash basis of accounting, based on your comment ""Cash, I think that's the only way for a sole propriator (sic)"" Consider: There are two distinct but similar-name concepts here: ""paid for"" (in relation to a expense) and ""paid off"" (in relation to a debt).  These both occur in the case you describe: Under the cash basis of accounting, when you can deduct an expense is based on when you paid for the expense, not when you eventually pay off any resulting debt arising from paying for the expense. Admittedly, ""cash basis"" isn't a great name because things don't solely revolve around cash. Rather, it's when money has changed hands – whether in the form of cash, check, credit card, etc.  Perhaps ""monetary transaction basis"" might have been a better name since it would capture the paid-for concept whether using cash or credit.  Unfortunately, we're stuck with the terminology the industry established."