I think the fundamental misunderstanding you have is that you think that Cash Flows from Financing Activities includes interest payments. It does not. In only includes principal repayments. Cash Flows from Operating Activities **does** include interest payments. Look at any Income Statement + Cash Flow Statement on any 10-K from sec.gov and you'll see this to be true. As Charlie Munger says, "I've never heard an intelligent cost of capital discussion". Cost of capital can mean two things, and it's often not clear which definition people are using. Cost of capital can mean: 1. how much it costs you to borrow money (e.g. 8% annualized interest rate to borrow \$1m with 10% outstanding principal repayment every year) 2. the opportunity cost of deploying your capital into whatever you're calculating NPV for (e.g. 9% historical nominal return from the S&P 500) The discount rate matters for the second. It doesn't matter for the first. When a finance textbooks suggest you should not include financial cashflows in capital budgeting, they mean that you should not include the financial cash inflow of **principal** and financial cash outflow of **principal**. However, this does not mean that you should not include the cash flows related to **interest**. If you look at any 10-K, you'll see that interest is absolutely accounted for in Cash Flows from Operating activities (from the Income Statement's Net Income) and not in Cash Flows from Financing Activities. Let's take an example. Let's say you're thinking about buying a private business for \$1m dollars that has \$1m book value (assets - liabilities, or in other words, equity) and returns 10% free cash flow every year for five years after which we liquidate the business and sell the \$1m of assets net of liabilities. For sake of example, the only other investment possibility you have is to invest in the S&P 500, which will return you 9% guaranteed (again, for sake of example). Because this 9% is your opportunity cost, it will be used as the discount factor. We'll first do the calculations using \$1m equity (money you own), then we'll do it with a mix of equity and debt with a specific cost of capital, where the cost of capital definition is the first one from above. Example 1 (Use \$1m equity to buy business): NPV = \$100,000 / 1.09 + \$100,000 / 1.09 ^ 2 + ... + \$100,000 / 1.09 ^ 5 + \$1,000,000 / 1.09 ^ 5 - \$1,000,000 NPV = 38,896.51 Example 2 (Use \$500k equity to buy business and \$500k debt at 5%): The **interest** payments are as follows, which I plugged into: https://www.creditkarma.com/calculators/amortization/ Year 1: \$22,950 Year 2: \$18,331 Year 3: \$13,476 Year 4: \$8,372 Year 5: \$3,008 Cumulative **principal** you've paid off every year is: Year 1: \$90,278 Year 2: \$185,174 Year 3: \$284,926 Year 4: \$389,780 Year 5: \$500,000 NPV = (\$100,000 - \$22,950) / 1.09 + (\$100,000 - \$18,331) / 1.09 ^ 2 + ... + (\$100,000 - \$3,008) / 1.09 ^ 5 + \$1,000,000 / 1.09 ^ 5 - \$500,000 NPV = \$95544.60 Notice that the principal payments don't get added to NPV because the interest is taking care of the cost of capital (first definition) and the principal is taking care of the original value of the loan. Also notice that the cost of debt here has nothing to do with the discount factor. The opportunity cost of capital has everything to do with it. The cost of capital (first definition) is handled by the interest payments on the numerator. Also notice that the NPV of the second calculation is bigger because your return on equity was higher (you only put up \$500,000 instead of \$1m). Hope this helps.