The Capricorn Company is launching a new venture in a field related to but separate from its present business. Management is proposing that financing for the new enterprise be supplied by a local bank, which it has approached for a loan. Capricorn’s finance department has done a capital budgeting analysis of the venture, projecting reasonable cash flows and calculating an NPV and an IRR that both look very favorable.
The bank’s loan officer, however, isn’t satisfied with the analysis. She insists on seeing a financial projection that calculates interest on cumulative cash flows, incorporates that interest as a cost of the project, and shows the buildup and decline of the debt necessary to accomplish the proposal. She essentially wants a business plan complete with projected financial statements. Reconcile the bank officer’s position with capital budgeting theory.