1 Illustration 1: Long Term Notes Payable May be interest bearing or non-interest bearing (we will look at non-interest bearing). May be serial notes (periodic payments) or term notes (balloon payments). We will look at balloon payments here (serial payments, or annuities, later). Illustration 1: On January, 2, 2008, Pearson Company purchases a section of land for its new plant site. Pearson issues a 5 year non-interest bearing note, and promises to pay $50,000 at the end of the 5 year period. What is the cash equivalent price of the land, if a 6 percent discount rate is assumed?

2 Illustration1 Solution See page 370, Table 9-2 PV1 Table PV1 = FV1( ) i, n PV1 Table i=6%, n=5 Journal entry Jan. 2, 2008: Land37,350 Discount on N/P12,650 Notes Payable 50,000 PV1 = 50,000 ( 0.747) = $37,350

3 Illustration1 Solution, continued Journal entry, December 31, 2008, assuming Pearson uses the straight-line method to recognize interest expense (12,650 / 5): Carrying value on B/S at 12/31/2008? Carrying value on B/S at 12/31/2012? Interest expense2,530 Discount on N/P 2,530 Notes Payable$50,000 Discount on N/P (10,120) $39,880 (Discount = 12, ,530 = 10,120) 50, = 50,000

4 Illustration 2: Investment Holliman Company wants to accumulate $500,000 at the end of 10 years. What amount must it invest today to achieve that balance, assuming a 6% interest rate, compounded annually? PV1 Table PV1 = ( ) = i=6%, n=10 What if the interest is compounded semiannually? PV1 Table PV1 = ( ) = 500, $279,000 n = 10 x 2 = 20 periods, i = 6% / 2 = 3% per period 500, i=3%, n=20 $277,000

5 Illustration 3: Long Term Notes Payable Illustration 3: On January, 2, 2008, Pearson Company purchases a section of land for its new plant site. Pearson issues a 5 year non-interest bearing note, and promises to pay $10,000 per year at the end of each of the next 5 years. What is the cash equivalent price of the land, if a 6 percent discount rate is assumed?

6 Illustration 3 Solution See page 372, Table 9-4 PVA Table PVA = A ( ) i, n PVA Table i=6%, n=5 Journal entry Jan. 2, 2008: Land42,120 Discount on N/P 7,880 Notes Payable 50,000 PVA = 10,000 ( 4.212) = $42,120

7 Illustration 4: Annuity Income Illustration 4: On January, 2, 2008, Donna Smith won the lottery. She was offered an annuity of $100,000 per year for the next 20 years, or $1,000,000 today as an alternative settlement. Which option should Donna choose. Assume that she can earn an average 4 percent return on her investments for the next 20 years. Solution: calculate the present value of the annuity at a discount rate of 4%.

8 Illustration 4 Solution See page 372, Table 9-4 PVA Table PVA = A ( ) i, n PVA Table i=4%, n=20 Which should she choose? At approximately what interest (discount) rate would she choose differently? (Based on whole percentage rate) Choose the annuity, PV > $1,000,000 PVA = 100,000 (13.590) = $1,359,000 At 8 % interest, PV < $1,000,000

9 Illustration 5: Investment Holliman Company wants to invest $200,000 cash it received from the sale of land. What amount will it accumulate at the end of 10 years, assuming a 6% interest rate, compounded annually? FV1 Table FV1 = PV1 ( ) i=6%, n=10 FV1 Table FV1 = ( ) = i=6%, n=10 200, $358,200

10 Illustration 6: Future Value of Investment Jane Smith wants to invest $10,000 each year for the next 20 years, for her retirement. What balance will she have at the end of 20 years, assuming a 6% interest rate, compounded annually? FVA Table FVA = A ( ) = i=6%, n=20 FVA Table FVA = ( ) = i=6%, n=20 10, $367,860

11 Illustration 7: Future Value of Investment James Holliman wants to accumulate $200,000 at the end of 10 years, for his son’s education fund. What equal amount must he invest annually to achieve that balance, assuming a 6% interest rate, compounded annually? FVA Table FVA = A ( ) = i=6%, n=10 FVA Table = ( ) i=6%, n=10 200, A A = 200,000/ = $15,173.36