In this workout we're asked to establish cashflow based debt capacity for Pizza Plc. Banks are currently willing to lend and amortizing five-year term loan A at 6% pre-tax cash interest. Effective tax rates is equivalent to marginal tax rates. Okay, so the first thing I want to do is I want to look at these cashflow available for debt service. I want to identify just the ones we're going to use and we're going to use the ones in years 1, 2, 3, 4, and 5. So I'm gonna highlight them so that we remember which ones we're using. Now the interesting thing about this particular debt is that it's going to be an amortizing debt. That means we're gradually paying off the principle as time goes on. So if I think about that first cashflow of 456.0, that needs to pay off some of the capital and the interest as we go. And the year two figure 478.6, that needs to pay off some of the capital and the interest as well. So what I could do to work out the amount of debt is I could take those 1, 2, 3, 4, 5 cash flows and I could present value them using the interest rate as the discount rate.

If we have a look at how much those cash flows add up to at the moment, they add up to 2,496.6. So I've got that amount of cash to pay for capital and pay off interest. Let's use the interest rates after tax. So it's 6% at the moment. Let's calculate it after tax.

Let's use that interest rate to discount those five cash flows.

I'm gonna use the NPV formula to help me out here. It asks me for the rate, first of all, which is 4.2 percent, and it then asks me for the value. So I select 1, 2, 3, 4, 5, and it comes to 2,202.6. That's interesting. In total I had 2,496.6, but the present values is 2,202.6. So the difference must be the interest along the way. Let's check. I can do this term A amortization schedule. I'll start with our ending balance of debt on the day. We take it out in year zero, 2,202.6. My beginning balance next period is the same amount, but the amount I owe then goes up. It goes up by the interest. So I'll take that interest rate. I'm gonna lock onto that, multiply it by the beginning balance and the amount of interest. It's 92.5. So I start with 2,202.6, but now the amount I owe is going up, has gone up by 92.5 oh dear. Hang on, that's okay though, because I can use the cashflow that we had at the top. I'm going to equals negative sign 456. I can use that to reduce the total balance. So I'm paying off the interest and I'm paying off some of the capital.

So the reason that my 2,202.6, the amount I borrowed is less than the total amount of cash is because that amount is because the 2,496.6 will pay off the capital 2,202.6 plus all of the interest. So let's see what happens at the end of year one. The balance has gone down to 1839.1. Let's copy that to the right and see what happens in year two. Does it go down again? Yes, it does. In year three, does it go down again? Yes, it does. In year four, it's gone down again. So now let's look at year five. My beginning balance in year five, the same amount.

Now you might look at the year five cash flow and think, hang on. 542.7. I don't need that amount of cash, do I? I only owe 520.8 at the start of the year, but of course we've forgotten the interest. So I'm going to copy the interest from the sell to the left to the right. Ah, I need to pay the interest as well. So if I need to pay the beginning balance plus the interest, I'll now take that 542.7, add it all up. Does it come to 0? It does. It does indeed. Great. So we can see that as time went on, the capital, which originally was less than the total cashflow available, gradually grew by the interest, but then went down by the cash paid. So how much was I able to borrow? It was the 2,202.6.