To meet the increasing demand for its microprocessors

Intelligent Micro
To meet the increasing demand for its microprocessors Intelligent Micro

To meet the increasing demand for its microprocessors, Intelligent Micro Devices began
construction of a new manufacturing facility on January 1, 2017. Construction costs were
incurred uniformly throughout 2017 and were recorded in the firm's Construction-in-progress
account. The average balance in the Construction-in-progress account during 2017 was $150
million. To facilitate the facility's construction, the firm arranged for an $80 million construction
loan on January 1 at a rate of 13%. The firm also issued $40 million of common stock to help
finance the project. Management estimates that the firm's cost of equity capital is 16%. On
January 1, 2017, the firm also issued bonds in the amount of $200 million carrying a weighted
average interest rate of 11.5%. Earnings before interest and taxes for 2017 is $50 million.
Required:
1. What is the total amount of interest the firm incurred in 2017?
2. Assume that the firm bases the amount of capitalized interest on the average balance in the
Construction-in-progress account. How much of the interest in requirement 1 should be
capitalized?
3. How much of the amount in requirement 2 will be related to the firm's common stock issue?
Why?
4. Where will the amount in requirement 2 appear in the firm's 2017 financial statements?
5. What amount of interest expense will appear in the firm's 2017 income statement?
6. Assume that the facility is completed on December 31, 2017, and that it is placed in service
on January 1, 2018. How, if at all, will the amount in requirement 2 affect the future income of
the firm?
7. Calculate the firm's interest coverage ratio (income before interest and taxes divided by
interest expense) with and without the interest capitalization. Which coverage ratio would be
more useful to a creditor in the evaluation of the firm's risk of insolvency?

To meet the increasing demand for its microprocessors Intelligent Micro

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