Which Cost of Debt Should be Used in Forecasting Cash Flows? (Updated)

Estudios Gerenciales, Vol. 24, No. 110, April/June 2009

17 Pages Posted: 12 Sep 2007 Last revised: 26 Jun 2012

See all articles by Ignacio Velez-Pareja

Ignacio Velez-Pareja

Grupo Consultor CAV Capital Advisory & Valuation

Date Written: March 15, 2009

Abstract

Frequently analysts and teachers use the capitalized rate of interest for the cost of debt when forecasting and discounting cash flows. On the other hand, some authors (and analysts) estimate the interest payments when forecasting annual financial statements or cash flows based on the average of debt calculated with the beginning balance and the end of year balance. This makes some sense because usually firms repay debt in a monthly or quarterly basis and calculating interest payments might not reflect reality. Others use the end of year convention that calculates the yearly interest multiplying the beginning balance times the contractual cost of debt.

In this teaching note we show the differences when we use those different approaches and make a simple proposal to solve the problem.

Keywords: Cost of debt, forecasting financial statements, seasonality

JEL Classification: G30, G31, G32

Suggested Citation

Velez-Pareja, Ignacio, Which Cost of Debt Should be Used in Forecasting Cash Flows? (Updated) (March 15, 2009). Estudios Gerenciales, Vol. 24, No. 110, April/June 2009. Available at SSRN: https://ssrn.com/abstract=1011485

Ignacio Velez-Pareja (Contact Author)

Grupo Consultor CAV Capital Advisory & Valuation ( email )

Ave Miramar # 18-93 Apt 6A
Cartagena
Colombia
+573112333074 (Phone)

HOME PAGE: http://cashflow88.com/decisiones/decisiones.html

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