Iterative Calculation

In an integrated model, interest expense flows into the income statement and reduces net income; net income flows into cash flow; cash flow determines how much debt is repaid (or how much revolver is drawn); and the debt balance determines interest expense. That's a genuine circular dependency — A depends on B which depends on A. Excel can't resolve a circular reference normally (it shows a warning and zeros). Enabling iterative calculation tells Excel to make a guess, recalc the loop, refine, and repeat until the change between iterations is below a tolerance (default 100 iterations, 0.001 max change). This produces the economically correct interest figure.

Go to File > Options > Formulas, check 'Enable iterative calculation,' and set Maximum Iterations (100 is usually plenty) and Maximum Change (0.001, or tighter for precision). Once on, the model converges automatically each recalc. The trade-offs: iterative calc is on at the workbook/application level, it can mask genuine accidental circular references (you lose Excel's warning), and any single cell error (#REF!, #DIV/0!) inside the loop propagates into a #VALUE! or 0 that the iteration can't recover from — freezing the whole model. That fragility is why many shops avoid it entirely.

Because iterative calc is fragile, most banks prefer a 'circularity breaker' (or 'circ switch'): a single toggle cell (1 = on, 0 = off) wired with an IF statement so that when it's 0, interest is calculated on beginning debt only (no circularity) and the loop is broken. You build the model with the switch off, then flip it on for the precise answer; if the model ever errors out, flip the switch off, fix the broken cell, and flip back on. Some modelers go further and use a copy-paste macro that computes interest on average debt and pastes it as a value, avoiding circularity altogether. The choice is a stability-vs-precision trade-off.