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With the given information below, how to find the interest cost in year 1,2 and 3?...

With the given information below, how to find the interest cost in year 1,2 and 3?

An investment company is planning to invest by buying over an existing hotel.

Some information concerning their project:

• Land will be purchased for a value of 7.5 millions ;

• A building will be constructed for a total value of 42 millions, estimated value after 10 years : 12 millions ;

• Equipment will be purchased for a value of 12 millions and will be completely depreciated over a period of 8 years ,

• Other investments are estimated to be 4,5 millions and will be completely depreciated after 5 years. This investment includes the purchase of the basic inventories, opening costs, etc…

• Revenues of the first year (365 days in a year) of operations are estimated as follow :

o Rooms division : 198 rooms per day at 500 francs per night

o Restaurant : 260 covers per day at averagely 100 francs per cover

o Breakfast : 150 covers per day at 20 francs each

o Banquet and convention centre : 4 millions

• An annual increase of 2% is expected ;

• The F&B costs are forecasted at 35% of F&B revenue ;

• Salaries and wages, including social charges, are forecasted at 40% of the total revenues ;

• Other operating costs, excepted depreciation costs and interest costs, are forecasted to be 16,000,000, increasing by 2% per year ;

• The income tax rate is of 35%

• The investment expenses are as follow :

o Year -1 : 85%

o Opening : 15%

• This project is financed as follow : 65% by contracting a mortgage, 35% with owner’s capital stock

• The mortgage contracted determines a interest rate of 5% and a fixed reimbursement of 3,5 millions, 1st payment at the end of year 1

• A dividend of 5% will be distributed to the shareholders starting from year 1

Solutions

Expert Solution

Total Investment
Land            7,500,000
Building          42,000,000
Equipment          12,000,000
Other Investment            4,500,000
Total          66,000,000

Given that 15% as investment expenses at opening i.e. Year 0

15% * 66,000,000 = 9,900,000

Also given the finance is done thorough 65% through mortgage and 35% through owners stock

Hence at the begining we need 65% *   9,900,000 as Loan i.e. 6, 435,000

Assuming 85% investment is needed at the end of the year interest is payable on 6 435 000 @ 5% for 1 year i.e. Interest payable for year 1 is 321750.

Also given fixed reimbursement of 3,5 millions, 1st payment at the end of year 1

Loan balance is coming to (321750 Int + Loan 6,435,000 - payment made 3500000) =  3256750

85% of the investment in year 1 is coming to 85% * 66,000,000 = 56,100,000

Mortgage amount = 56,100,000 * 65% = 36465000

Total mortgage balance at year 1 ending = (36465000 + 3256750) = 39721750

Interest Cost in Year 2 = (39721750 * 5%) = 1986088

Total mortgage balance at Year 2 ending = (39721750 pricipal + 39721750 * 5 % interest - 3500000) = 38 207838

Interest Cost in Year 3 = (38207838 * 5%) = 1910392

Alternatively we can assume that investment was made in the made in the middle of the year then interest will be calulated from 6 months in year 1


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