Question

Firm X decided to construct a new building for their corporate headquarters. The company made three separate $1,000,000 expenditures related to the construction. The first was expenditure was made on 1/1/1, the second on 7/1/1, and the third on 10/1/1.

To help finance the construction, Firm X took out a 5-year, 12% loan for $1,200,000. Assume the weighted-average interest rate on all the firm’s other debt is 10%.

On 3/1/2, the firm makes an additional $300,000 expenditure related to the construction of their building. Construction is completed on 9/30/Yr2. Firm X incurred $500,000 of interest costs on all its debt during Year 2. Calculate Firm X’s avoidable interest for Year 2

Answer 1

Date of Payment	Payment Amount	Funds Used time	Annualized Fund
1-1-1	$10,00,000	12 months	$1,000,000
7-1-1	$10,00,000	6 months	$500,000
10-1-1	$10,00,000	3 months	$250,000
Total Amount Qualifying interest capitalization			$17,50,000

First Year Eligible Interest=12,00,000*12% +(17,50,000-12,00,000)*10%=$144,000+$55,000=$199,000.

2^nd Year except the amount invested last Year

Date of Payment	Payment Amount	Funds Used time	Annualized Fund
1-1-2	$10,00,000	9 months	$750,000
1-1-2	$10,00,000	9 months	$750,000
1-1-2	$10,00,000	9 months	$750,000
3-1-2	$300,000	7 Months	175,000
Total Amount Qualifying interest capitalization			$24,25,000

Second Year Eligible Interest=$12,00,000*12% +(24,25,000-12,00,000)*10%

=$144,000 + $122,500=$266,500.

Avoidable Interest = First Year Eligible Interest + Second Year Eligible Interest

   =$199,000+$266500=$465,500

Note: For the Loans up to 12 lacks which is specific loan,The rate of interest of specific loan is applied throughout the period of construction and For the remaining Balance have used weighted average cost of capital which is given in the Problem.