QS Study

Exclusion of financing cost: Income that is not considered gross income for tax purposes. Exclusions include gifts, inheritance, and some other. It is important to note that just because a type of income is exclusion, it does not mean that it is not taxed; it simply may be taxed differently. When cash flows relating to long-term funds are being defined, financing costs of long-term funds (interest on long-term debt and equity dividend ) should be excluded from the analysis. The question arises why?

The exclusion of financial cost means that the interest on loan term debt is ignored while computing profit and taxes and; the expected dividends are deemed irrelevant in cash flow analysis. The subjective average cost of capital used for evaluating the cash flows takes into account the cost of long-term funds. Put in a different way, the interest and dividend payments are reflected in subjective average cost of capital used for evaluating the cash flows takes into account the cost of long-term funds. Put differently, the interest and dividend payments are reflected in the; subjective average cost of capital. Therefore, if interest on long-term debt and dividend on equity capital are deducted in defining the cash flows, the cost of long-term funds will be counted twice.