Question

Novak Company is constructing a building. Construction began on February 1 and was completed on December 31. Expenditures were $5,400,000 on March 1, $3,600,000 on June 1, and $9,000,000 on December 31. Novak Company borrowed $3,000,000 on March 1 on a 5-year, 12% note to help finance construction of the building. In addition, the company had outstanding all year a 10%, 5-year, $6,000,000 note payable and an 11%, 4-year, $10,500,000 note payable. Compute avoidable interest for Novak Company. Use the weighted-average interest rate for interest capitalization purposes.

Answer 1

Answer:

Avoidable interest 557,181.82  

Explanation:

construction capitalized interest  

time nominal expenditure  portion of year     weight

march 1  5,400,000.00  0.833333333  4,500,000.00

june 1  3,600,000.00  0.583333333  2,100,000.00

weighted expenditures               6,600,000.00

Then:

especific borrowings rate 0.12  

especific amaount 3,000,000

construction specific interest 270,000.00  

remainder for non-specifit borrowings

6,600,000 - 3,000,000 = $ 3,600,000.00

average rate  

principal       rate interest

6,000,000 0.1 600000

10,500,000 0.11 1155000

16,500,000  1755000

total interest / total principal = 0.106363636

capitalized from non-specific borrowing

3,600,000.00  x 0.106363636 =  287,181.82  

 Total avoidable (capitalized interest) =

270,000.00 + 287,181.82 = 557,181.82  

Answer 2

Answer: $742910

Explanation:

The weighted average combines interest rates into a single interest rate which yields a combined cost which is about thesame as cost of the original separate loans.

The weighted-average interest rate for interest capitalization purposes for the company above is calculated in the attachment below.