During the current year, a firm has been constructing a building to be used for its production facility. The average cost of the building in process is $1,250,000. The firm has borrowed $750,000 at 6 percent interest to finance this construction. It has $2,500,000 of 10 percent debentures and $500,000 of 7.5 percent mortgage debt outstanding. What is the capitalized construction interest and the total interest expense? Capitalized Interest Total Interest Expense A) $75,000 $332,500. B) $95,000 $332,500. C) $75,000 $237,500. D) $95,000 $237,500. Your answer: A was incorrect. The correct answer was D) $95,000 $237,500. Interest of construction debt: $750,000 x 6.00% = $45,000 Interest on debentures: $500,000 x 10.00 % = $50,000 Total capitalized interest: = $95,000 Total interest expense = Total interest paid - Capitalized interest = $45,000 + $250,000 + $37,500 - $95,000 = $237,500 The interest expense on the outstanding mortgage can be ignored, as it is not part of the construction costs of the new building. I wasn’t exactly sure how to do this question, however, I don’t think the explanation they gave was correct. It says that the interest on debentures was $50,000, attained by taking 10 percent of 500,000. The issue I have is that the problem statement says that there were $2,500,000 worth of debentures. Anyone have any input on this?
The 50,000 is only what has been taken for the construction project thro’ the debt option. (have ignored 000 below) 1250 is total cost of building 750 is borrowed @ 6% interest. rest must have come from debt == 500. Hope this helps. I am able to derive this only based on the solution above. Not sure if I would get this in the absence of a solution in the exam…!!! CP
Yeah that definitely makes sense. The fact that the mortgage was also 500k tripped me up.