Interest is the cost of using money. It is the rental charge for funds, just as renting a building and equipment entails a rental charge. When the funds are used for a period of time, it is necessary to recognize interest as a cost of using the borrowed (“rented”) funds. This requirement applies even if the funds represent ownership capital and if interest does not entail an outlay of cash. Why must interest be considered? Because the selection of one alternative automatically commits a given amount of funds that could otherwise be invested in some other alternative.
Interest is generally important, even when short-term projects are under consideration. Interest looms correspondingly larger when long-run plans are studied. The rate of interest has significant enough impact to influence decisions regarding borrowing and investing funds. For example, $100,000 invested now and compounded annually for 10 years at 8% will accumulate to $215,900; at 20%, the $100,000 will accumulate to $619,200.