LINK TO TEXT Novak Furniture Company started construction of a combination offic
ID: 2525159 • Letter: L
Question
LINK TO TEXT
Novak Furniture Company started construction of a combination office and warehouse building for its own use at an estimated cost of $5,035,100 on January 1, 2017. Novak expected to complete the building by December 31, 2017. Novak has the following debt obligations outstanding during the construction period.Construction loan-10% interest, payable semiannually, issued December 31, 2016 $2,016,600 Short-term loan-8% interest, payable monthly, and principal payable at maturity on May 30, 2018 1,589,000 Long-term loan-9% interest, payable on January 1 of each year. Principal payable on January 1, 2021 997,900
Explanation / Answer
1) Construction loan will be considered as specific loan and other two loans will be considered as general loan. Therefore we need to calculate weighted average interest rate for two general loans for calculating avoidable interest which is shown as follows:-
Interest on short term loan = Loan Amount*Interest Rate
= $1,589,000*8% = $127,120
Interest on Long term loan = Loan Amount*Interest Rate
= $997,900*9% = $89,811
Weighted Average Interest Rate = Total Interest/Total Loan Amount
= ($127,120+$89,811)/($1,589,000+$997,900)
= $216,931/$2,586,900 = 8.39%
Interest on Construction loan = $2,016,600*10% = $201,660
Interest on remaining accumulated expenditure = ($3,826,900 - $2,016,600)*8.39% = $151,884
Total Avoidable Interest = Interest on Construction Loan+Interest on remaining general loan
= $201,660+$151,884 = $353,544
2) Total Cost to be capitalized = Cost incurred+Total Avoidable Interest
= $5,203,700+$353,544 = $5,557,244
Depreciation Expense per year = (Cost Capitalized - Salvage Value)/Useful Life
= ($5,557,244 - $302,400)/30 yrs = $175,161 per year
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