Interest Capitalization Example adopted from textbook 1 First

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

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

Interest Capitalization Example 2) Second, compute weighted-average funding needs to 1. make these expenditures

Interest Capitalization Example 2) Second, compute weighted-average funding needs to 1. make these expenditures Jan 1: Mar 1: May 1: Dec 31: $210, 000 300, 000 540, 000 450, 000 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.

Interest Capitalization Example 2) Second, compute weighted-average funding needs to 1. make these expenditures Jan 1: Mar 1: May 1: Dec 31: $210, 000 300, 000 540, 000 450, 000 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.

Interest Capitalization Example 2) Second, compute weighted-average funding needs to 1. make these expenditures Date Amount Jan 1 $210, 000 Mar 1 300, 000 May 1 540, 000 Dec 31 450, 000 Total Interest Accrual period Weighted. Average Funding Needs

Interest Capitalization Example 2) Second, compute weighted-average funding needs to 1. make these expenditures Date Amount Interest Accrual period Jan 1 $210, 000 12 mos. /12 mos. Mar 1 300, 000 May 1 540, 000 Dec 31 450, 000 Total Weighted. Average Funding Needs

Interest Capitalization Example 2) Second, compute weighted-average funding needs to 1. make these expenditures Date Amount Interest Accrual period Weighted. Average Funding Needs Jan 1 $210, 000 12/12 $210, 000 Mar 1 300, 000 May 1 540, 000 Dec 31 450, 000 Total

Interest Capitalization Example 2) Second, compute weighted-average funding needs to 1. make these expenditures Date Amount Interest Accrual period Weighted. Average Funding Needs Jan 1 $210, 000 12/12 $210, 000 Mar 1 300, 000 10/12 250, 000 May 1 540, 000 Dec 31 450, 000 Total

Interest Capitalization Example 2) Second, compute weighted-average funding needs to 1. make these expenditures Date Amount Interest Accrual period Weighted. Average Funding Needs Jan 1 $210, 000 12/12 $210, 000 Mar 1 300, 000 10/12 250, 000 May 1 540, 000 8/12 360, 000 Dec 31 450, 000 Total

Interest Capitalization Example 2) Second, compute weighted-average funding needs to 1. make these expenditures Date Amount Interest Accrual period Weighted. Average Funding Needs Jan 1 $210, 000 12/12 $210, 000 Mar 1 300, 000 10/12 250, 000 May 1 540, 000 8/12 360, 000 Dec 31 450, 000 0/12 0 Total

Interest Capitalization Example 2) Second, compute weighted-average funding needs to 1. make these expenditures Date Amount Interest Accrual period Weighted. Average Funding Needs Jan 1 $210, 000 12/12 $210, 000 Mar 1 300, 000 10/12 250, 000 May 1 540, 000 8/12 360, 000 Dec 31 450, 000 0/12 0 Total 820, 000 This represents the average amount of funding (borrowing) the company had to pay interest on, during the year, for the ongoing project.

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

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 • 10%, 5 year note • 12%, 10 year bonds $750, 000 $550, 000 $600, 000 Total funds available from debt $1, 900, 000

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 • 10%, 5 year note • 12%, 10 year bonds $750, 000 $550, 000 $600, 000 Construction funding needs = $820, 000 (computed earlier)

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 • 10%, 5 year note • 12%, 10 year bonds $750, 000 $550, 000 $600, 000 Construction funding needs = $820, 000 (computed earlier) • $750, 000 from 15% construction note

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 • 10%, 5 year note • 12%, 10 year bonds $750, 000 $550, 000 $600, 000 Construction funding needs = $820, 000 (computed earlier) • $750, 000 from construction note • $70, 000 remaining from both 10% note and 12% bonds

Interest Capitalization Example 4) Fourth, compute interest accrued for funding needs Construction funding needs = $820, 000 (computed earlier) Amount Source $750, 000 15% Construction Note $70, 000 10% Note 12% Bonds Interest Rate for Source Interest Accrued

Interest Capitalization Example 4) Fourth, compute interest accrued for funding needs Construction funding needs = $820, 000 (computed earlier) Amount Source Interest Rate for Source $750, 000 15% Construction Note 15% $70, 000 10% Note 12% Bonds Interest Accrued

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

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

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

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

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

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

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

Interest Capitalization Example 4) Fourth, compute interest accrued for funding needs Construction funding needs = $820, 000 (computed earlier) Amount Source Interest Rate for Source $750, 000 15% Construction Note 15% $70, 000 10% Note 12% Bonds Weighted Average: 127, 000 = 11. 04% 1, 150, 000 Debt Type Interest Accrued Principal Interest 10% Note $550, 000 $55, 000 12% Bonds $600, 000 $72, 000 $1, 150, 000 $127, 000 Totals

Interest Capitalization Example 4) Fourth, compute interest accrued for funding needs Construction funding needs = $820, 000 (computed earlier) Amount Source Interest Rate for Source $750, 000 15% Construction Note 15% $70, 000 10% Note 12% Bonds 11. 04% Weighted Average: 127, 000 = 11. 04% 1, 150, 000 Interest Accrued

Interest Capitalization Example 4) Fourth, compute interest accrued for funding needs Construction funding needs = $820, 000 (computed earlier) Amount Source Interest Rate for Source Interest Accrued $750, 000 15% Construction Note 15% 112, 500 $70, 000 10% Note 12% Bonds 11. 04% 7, 728 Total $120, 228

Interest Capitalization Example 4) Fourth, compute interest accrued for funding needs Construction funding needs = $820, 000 (computed earlier) Amount Source Interest Rate for Source Interest Accrued $750, 000 15% Construction Note 15% 112, 500 $70, 000 10% Note 12% Bonds 11. 04% 7, 728 Total This is “avoidable” interest. $120, 228

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

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

Interest Capitalization Example 5) Fifth, capitalize lesser of total interest paid by firm and “avoidable” interest • Avoidable interest • Total interest paid: $120, 228 15% Construction Note 750, 000 x 0. 15 112, 500 10% Note 550, 000 x 0. 10 55, 000 12% Bonds 600, 000 x 0. 12 72, 000 Total $239, 500

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