[r1racer]

1. A firm begins construction on January 1 by making a $40,000 construction payment to a contractor. On July 1, another $40,000 payment is made. AAE = $40,000 + $40,000(6/12) = $60,000. The July 1 payment was invested in the project only half of a year. The $60,000 represents the amount of debt, outstanding the entire year, which could have been retired.

I am a little confused here. Why would the 60,000 represent the amount for the entire year that could have been retired if 40,000 was paid on Jan 1? I am 100% lost on the concept “the amount of debt…which could have been retired.”

[MikeHoncho]

If the construction never took place, the construction expenditures would have been avoided, and these payments could have been used to repay old debt. That being said, AAE is basically the amount of debt that could have been retired. It is computed on an annual basis. So the first payment of 40,000 was outstanding for 12/12 of the year (the entire year) while the second payment of 40,000 was outstanding for half of the year. Since the second payment of 40,000 was only invested in the construction project for half of the year, Interest was being incurred for that half of the year which could have been avoided. So the full first payment of 40,000 plus 20,000 (half of the second payment) equals 60,000 ( the amount of debt that could have been avoided on an annual basis). Annual basis is the key.

Done: 5/22/14

"Always do sober what you said you'd do drunk. That will teach you to keep your mouth shut."
- Ernest Hemingway

[MikeHoncho]

If the construction never took place, the construction expenditures would have been avoided, and these payments could have been used to repay old debt. That being said, AAE is basically the amount of debt that could have been retired. It is computed on an annual basis. So the first payment of 40,000 was outstanding for 12/12 of the year (the entire year) while the second payment of 40,000 was outstanding for half of the year. Since the second payment of 40,000 was only invested in the construction project for half of the year, Interest was being incurred for that half of the year which could have been avoided. So the full first payment of 40,000 plus 20,000 (half of the second payment) equals 60,000 ( the amount of debt that could have been avoided on an annual basis). Annual basis is the key.

Done: 5/22/14

"Always do sober what you said you'd do drunk. That will teach you to keep your mouth shut."
- Ernest Hemingway

[MikeHoncho]

Hope this helps, I realize it might not have been the clearest explanation. I'm not that good at explaining things

Done: 5/22/14

"Always do sober what you said you'd do drunk. That will teach you to keep your mouth shut."
- Ernest Hemingway

[MikeHoncho]

Hope this helps, I realize it might not have been the clearest explanation. I'm not that good at explaining things

Done: 5/22/14

"Always do sober what you said you'd do drunk. That will teach you to keep your mouth shut."
- Ernest Hemingway

[r1racer]

Ahhh…got it. So the assumption is made that a company has other debt. I was thinking that the concept was applied to the current debt from construction. Appreciate.

[r1racer]

Ahhh…got it. So the assumption is made that a company has other debt. I was thinking that the concept was applied to the current debt from construction. Appreciate.

[Author]

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