Question

Ayayai Furniture Company started construction of a combination office and warehouse building for its own use at an estimated cost of $3,000,000 on January 1, 2020. Ayayai expected to complete the building by December 31, 2020. Ayayai has the following debt obligations outstanding during the construction period.

Construction loan-12% interest, payable semiannually, issued December 31, 2019 $1,200,000
Short-term loan-10% interest, payable monthly, and principal payable at maturity on May 30, 2021 840,000
Long-term loan-11% interest, payable on January 1 of each year. Principal payable on January 1, 2024 600,000
(a) Assume that Ayayai completed the office and warehouse building on December 31, 2020, as planned at a total cost of $3,120,000, and the weighted average amount of accumulated expenditures was $2,160,000. Compute the avoidable interest on this project. (Use interest rates rounded to 4 decimal places, e.g. 7.5825% for computational purposes and round final answers to O decimal places, e.g. 5,275.) Avoidable Interest $__________.

Answer 1

Ayayai Furniture Company

The avoidable interest on this project is:

= $250,909.44

Step-by-step explanation:

a) Data and Calculations:

Estimated cost of construction = $3,000,000

Construction started on January 1, 2020

Construction expected to complete by December 31, 2020

Debt obligations outstanding:

Construction loan-12% interest, payable semiannually, issued December 31, 2019 $1,200,000

Annual interest payment = $144,000 ($1,200,000 * 12%)

Short-term loan-10% interest, payable monthly, and principal payable at maturity on May 30, 2021 840,000;

Annual interest payment = $84,000 ($840,000 * 10%)

Long-term loan-11% interest, payable on January 1 of each year. Principal payable on January 1, 2024 600,000

Annual interest payment = $66,000 ($600,000 * 11%)

Total debt obligations = $2,640,000

Total interest payment = $294,000

Weighted average interest rate = $294,000/2,640,000 = 0.111364

Total cost of construction incurred = $3,120,000

Weighted average amount of accumulated expenditure = $2,160,000

Avoidable interest = Construction loan *12% + (Weighted Average Accumulated Expenditures - Construction loan) *Weighted average interest rate

= $1,200,000 * 12% + ($2,160,000 - $1,200,000) * 11.1364%

= $144,000 + (960,000 *11.1364%)

= $144,000 + $106,909.44

= $250,909.44

b) Avoidable interest is the interest that would not have been incurred assuming that this combination office and warehouse building project was not carried out.