# CFI Mock afternoon question 64

My gut reaction was 260k and could not figure out what was wrong here. Why would you only capitailze half of the 8%? I understand that he is proabably making semi-annual payments, shouldnt capitalize preferred dividends and should deduct invested earnings. I guess I am missing something…

I think it’s more the phrasing of the question.

The part regarding invest 2m. They probably mean it as annual rate rather than a 7% HPY, if you do it that way, you’ll get \$330k p.s. I did calculate it as HPY at first.

Im not following you…this is how they calculated it:

Capitalized costs = Interest costs 0.08 × 5,000,000 = 400,000 Less interest income 0.07 × 2,000,000 × ½ = (70,000) Total capitalized costs 330,000

Basically, with respect to your original question…

You shouldn’t capitalise preference shares, my guess is because according to them, pref shares have no maturity.

Btw, what did you mean by half of the 8%?

The rest is as they say.

ahhhhh! I see it now…i was thinking they only capitalized half of the interest expense but they deducted the 6-month return on the 7% earnings. I get it now, thanks for the help

This question pissed me off immensly. They said they earned 7% on their six month investment… and we’re supposed to know that 7% is supposed to be divided by 2 because they stated the return as if it were a full year investment. Who does that? They EARNED 7% on that amount is what it says… how in the world does that mean anything different than what it says. 2,000,000 x .07 … why would it not be that?

No problem. I initially intepreted it as HPY of 7% (in other words same as you did, over 6 months) too.

I totally understand what you mean. It would be even more evil if they had included \$260k as one of their answers.

The question seemed rather simple to me.

And It’s given in the reading,

‘Under IFRS, income earned by temporaily investing borrowed funds reduces the interest that is eligible for capitalization. There is no such reduction of capitalized interest under US GAAP.’

So \$400k as the interest cost on \$4m @ 8% for the whole year Less the interest earned \$70k @ 3.5% (as it’s invested only for 6 months).

It was actually the 7% that was halved because the \$2m portion of the loan proceeds was only invested for the first six months. They borrowed 5m and would have paid 400k (8% x 5m) had they not invested a portion of it. But they invested 2m out of that 5m so the interest income earned from that investment should be deducted from the total interest expense to get the borrowing cost.

Isn’t it that rates are GENERALLY given on annual terms? It’s sort of a banking convention. It is usually the case even with fixed income so unless otherwise stated, I think we are to assume that the rate given is annual.

The question is worded very poorly… Generally, when someone says they earned 7% on their \$ investments, it means they earned 7% on their investment. I wouldn’t quote my first 6-month performance in the market on a BEY, that would be silly!

I agree we have to assume everything in the FI section is stated as a BEY…