A contractor is bidding a construction project that will take 12 months to complete. The terms of the bid provide that the owner will pay the Contractor one lump sum at the end of 14-months. The Contractor secured a bank loan with an interest rate of 1% per month on the outstanding balance. The Contractor will borrow $100,000 per month to reconcile costs at the end of months 1 through 12. Calculate the cost to finance the project that will be included as part of the bid.
Solution: At the end of month 12, the contractor will have borrowed 12 payments of $100,000 each. The owner is scheduled to pay the contractor at the end of month 14 at which time the contractor will repay the bank. Use the following equation to calculate the future value then extract the cost of financing the project:
F = $100,000 (F/A, 1%, 12) (F/P, 1%, 2) = $1,293,700
Amount Borrowed =$1,200,000
Amount of interest =$ 93,700