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

2. 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

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

4. 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.

5. 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.

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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

12. 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.

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

14. 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

15. 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)

16. 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

17. 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

18. 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

19. 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

20. 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

21. 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:

22. 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

23. 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

24. 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

25. 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

26. 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

27. 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%

28. 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%

29. 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

30. 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.

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

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

33. 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

34. 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