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Interest Capitalization Example (adopted from textbook) 1)First, identify when and how much the firm paid for actual building expenditures during the year

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Interest Capitalization Example 1)First, identify when and how much the firm paid for actual building expenditures during the year Jan 1:$210,000 Mar 1: 300,000 May 1: 540,000 Dec 31: 450,000

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Interest Capitalization Example 2)Second, compute weighted-average funding needs to make these expenditures

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Jan 1:$210,000 Mar 1: 300,000 May 1: 540,000 Dec 31: 450,000 Interest Capitalization Example 2)Second, compute weighted-average funding needs to make these expenditures This method assumes the firm borrows $210,000 for the full year then $300,000 for 10 months of the year then $540,000 for 8 months of the year, in order to make this payment schedule.

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Jan 1:$210,000 Mar 1: 300,000 May 1: 540,000 Dec 31: 450,000 Interest Capitalization Example 2)Second, compute weighted-average funding needs to make these expenditures Note that this method also assumes that the firm borrows $450,000 on the last day of the year. This will not accrue interest during this particular year, so we will ignore it.

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Interest Capitalization Example 2)Second, compute weighted-average funding needs to make these expenditures DateAmountInterest Accrual period Weighted- Average Funding Needs Jan 1$210,000 Mar 1300,000 May 1540,000 Dec 31450,000 Total

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Interest Capitalization Example 2)Second, compute weighted-average funding needs to make these expenditures DateAmountInterest Accrual period Weighted- Average Funding Needs Jan 1$210,00012 mos./12 mos. Mar 1300,000 May 1540,000 Dec 31450,000 Total

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Interest Capitalization Example 2)Second, compute weighted-average funding needs to make these expenditures DateAmountInterest Accrual period Weighted- Average Funding Needs Jan 1$210,00012/12$210,000 Mar 1300,000 May 1540,000 Dec 31450,000 Total

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Interest Capitalization Example 2)Second, compute weighted-average funding needs to make these expenditures DateAmountInterest Accrual period Weighted- Average Funding Needs Jan 1$210,00012/12$210,000 Mar 1300,00010/12250,000 May 1540,000 Dec 31450,000 Total

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Interest Capitalization Example 2)Second, compute weighted-average funding needs to make these expenditures DateAmountInterest Accrual period Weighted- Average Funding Needs Jan 1$210,00012/12$210,000 Mar 1300,00010/12250,000 May 1540,0008/12360,000 Dec 31450,000 Total

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Interest Capitalization Example 2)Second, compute weighted-average funding needs to make these expenditures DateAmountInterest Accrual period Weighted- Average Funding Needs Jan 1$210,00012/12$210,000 Mar 1300,00010/12250,000 May 1540,0008/12360,000 Dec 31450,0000/120 Total

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Interest Capitalization Example 2)Second, compute weighted-average funding needs to make these expenditures DateAmountInterest Accrual period Weighted- Average Funding Needs Jan 1$210,00012/12$210,000 Mar 1300,00010/12250,000 May 1540,0008/12360,000 Dec 31450,0000/120 Total820,000 This represents the average amount of funding (borrowing) the company had to pay interest on, during the year, for the ongoing project.

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Interest Capitalization Example 3)Third, map company’s existing debt to the amount of weighted average funding needs you just computed

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Interest Capitalization Example 3)Third, map company’s existing debt to the amount of weighted average funding needs you just computed December 31 debt outstanding: 15%, 3 year note to finance construction$750,000 10%, 5 year note$550,000 12%, 10 year bonds$600,000 Total funds available from debt$1,900,000

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Interest Capitalization Example 3)Third, map company’s existing debt to the amount of weighted average funding needs you just computed December 31 debt outstanding: 15%, 3 year note to finance construction$750,000 10%, 5 year note$550,000 12%, 10 year bonds$600,000 Construction funding needs = $820,000 (computed earlier)

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Interest Capitalization Example 3)Third, map company’s existing debt to the amount of weighted average funding needs you just computed December 31 debt outstanding: 15%, 3 year note to finance construction$750,000 10%, 5 year note$550,000 12%, 10 year bonds$600,000 Construction funding needs = $820,000 (computed earlier) $750,000 from 15% construction note

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Interest Capitalization Example 3)Third, map company’s existing debt to the amount of weighted average funding needs you just computed December 31 debt outstanding: 15%, 3 year note to finance construction$750,000 10%, 5 year note$550,000 12%, 10 year bonds$600,000 Construction funding needs = $820,000 (computed earlier) $750,000 from construction note $70,000 remaining from both 10% note and 12% bonds

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Interest Capitalization Example 4)Fourth, compute interest accrued for funding needs Construction funding needs = $820,000 (computed earlier) AmountSourceInterest Rate for Source Interest Accrued $750,00015% Construction Note $70,00010% Note 12% Bonds

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Interest Capitalization Example 4)Fourth, compute interest accrued for funding needs Construction funding needs = $820,000 (computed earlier) AmountSourceInterest Rate for Source Interest Accrued $750,00015% Construction Note 15% $70,00010% Note 12% Bonds

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Interest Capitalization Example 4)Fourth, compute interest accrued for funding needs Construction funding needs = $820,000 (computed earlier) AmountSourceInterest Rate for Source Interest Accrued $750,00015% Construction Note 15% $70,00010% Note 12% Bonds Weighted Average

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Interest Capitalization Example 4)Fourth, compute interest accrued for funding needs Construction funding needs = $820,000 (computed earlier) AmountSourceInterest Rate for Source Interest Accrued $750,00015% Construction Note 15% $70,00010% Note 12% Bonds Weighted Average:

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Interest Capitalization Example 4)Fourth, compute interest accrued for funding needs Construction funding needs = $820,000 (computed earlier) AmountSourceInterest Rate for Source Interest Accrued $750,00015% Construction Note 15% $70,00010% Note 12% Bonds Weighted Average: Debt TypePrincipalInterest 10% Note$550,000 12% Bonds

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Interest Capitalization Example 4)Fourth, compute interest accrued for funding needs Construction funding needs = $820,000 (computed earlier) AmountSourceInterest Rate for Source Interest Accrued $750,00015% Construction Note 15% $70,00010% Note 12% Bonds Weighted Average: Debt TypePrincipalInterest 10% Note$550,000$55,000 12% Bonds

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Interest Capitalization Example 4)Fourth, compute interest accrued for funding needs Construction funding needs = $820,000 (computed earlier) AmountSourceInterest Rate for Source Interest Accrued $750,00015% Construction Note 15% $70,00010% Note 12% Bonds Weighted Average: Debt TypePrincipalInterest 10% Note$550,000$55,000 12% Bonds$600,000

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Interest Capitalization Example 4)Fourth, compute interest accrued for funding needs Construction funding needs = $820,000 (computed earlier) AmountSourceInterest Rate for Source Interest Accrued $750,00015% Construction Note 15% $70,00010% Note 12% Bonds Weighted Average: Debt TypePrincipalInterest 10% Note$550,000$55,000 12% Bonds$600,000$72,000

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Interest Capitalization Example 4)Fourth, compute interest accrued for funding needs Construction funding needs = $820,000 (computed earlier) AmountSourceInterest Rate for Source Interest Accrued $750,00015% Construction Note 15% $70,00010% Note 12% Bonds Weighted Average: Debt TypePrincipalInterest 10% Note$550,000$55,000 12% Bonds$600,000$72,000 Totals$1,150,000$127,000

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Interest Capitalization Example 4)Fourth, compute interest accrued for funding needs Construction funding needs = $820,000 (computed earlier) AmountSourceInterest Rate for Source Interest Accrued $750,00015% Construction Note 15% $70,00010% Note 12% Bonds Weighted Average: Debt TypePrincipalInterest 10% Note$550,000$55,000 12% Bonds$600,000$72,000 Totals$1,150,000$127,000 127,000 1,150,000 = 11.04%

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Interest Capitalization Example 4)Fourth, compute interest accrued for funding needs Construction funding needs = $820,000 (computed earlier) AmountSourceInterest Rate for Source Interest Accrued $750,00015% Construction Note 15% $70,00010% Note 12% Bonds 11.04% Weighted Average: 127,000 1,150,000 = 11.04%

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Interest Capitalization Example 4)Fourth, compute interest accrued for funding needs Construction funding needs = $820,000 (computed earlier) AmountSourceInterest Rate for Source Interest Accrued $750,00015% Construction Note 15%112,500 $70,00010% Note 12% Bonds 11.04%7,728 Total$120,228

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Interest Capitalization Example 4)Fourth, compute interest accrued for funding needs Construction funding needs = $820,000 (computed earlier) AmountSourceInterest Rate for Source Interest Accrued $750,00015% Construction Note 15%112,500 $70,00010% Note 12% Bonds 11.04%7,728 Total$120,228 This is “avoidable” interest.

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Interest Capitalization Example 5)Fifth, capitalize lesser of total interest paid by firm and “avoidable” interest

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Interest Capitalization Example 5)Fifth, capitalize lesser of total interest paid by firm and “avoidable” interest Avoidable interest $120,228 Total interest paid:

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Interest Capitalization Example 5)Fifth, capitalize lesser of total interest paid by firm and “avoidable” interest Avoidable interest $120,228 Total interest paid: 15% Construction Note 750,000 x 0.15112,500 10% Note550,000 x 0.1055,000 12% Bonds600,000 x 0.1272,000 Total$239,500

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Interest Capitalization Example 5)Fifth, capitalize lesser of total interest paid by firm and “avoidable” interest Avoidable interest $120,228 Total interest paid:$239,500

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