Appendix C- 1. Appendix C- 2 Appendix C Time Value of Money Accounting Principles, Ninth Edition.

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Presentation transcript:

Appendix C- 1

Appendix C- 2 Appendix C Time Value of Money Accounting Principles, Ninth Edition

Appendix C Distinguish between simple and compound interest Identify the variables fundamental to solving present value problems Solve for present value of a single amount Solve for present value of an annuity Compute the present value of notes and bonds. Study Objectives

Appendix C- 4 In accounting (and finance), the term indicates that a dollar received today is worth more than a dollar promised at some time in the future. Basic Time Value Concepts Time Value of Money

Appendix C- 5 Payment for the use of money. Excess cash received or repaid over the amount borrowed (principal). Variables involved in financing transaction: 1. Principal (p) - Amount borrowed or invested. 2. Interest Rate (i) – An annual percentage. 3. Time (n) - The number of years or portion of a year that the principal is outstanding. Nature of Interest

Appendix C- 6 Interest computed on the principal only. SO 1 Distinguish between simple and compound interest. Nature of Interest ILLUSTRATION: On January 2, 2010, Tomalczyk borrows $20,000 for 3 years at a rate of 7% per year. Calculate the annual interest cost. Principal $20,000 Interest ratex 7% Annual interest$ 1,400 FULL YEAR Simple Interest

Appendix C- 7 Nature of Interest - Simple Interest ILLUSTRATION continued: On March 31, 2010, Tomalczyk borrows $20,000 for 3 years at a rate of 7% per year. Calculate the interest cost for the year ending December 31, Principal $20,000 Interest ratex 7% Annual interest$ 1,400 Partial year x 9/12 Interest for 9 months$ 1,050 PARTIAL YEAR SO 1 Distinguish between simple and compound interest.

Appendix C- 8 Nature of Interest SO 1 Distinguish between simple and compound interest. Computes interest on  the principal and  any interest earned that has not been paid or withdrawn. Most business situations use compound interest. Compound Interest

Appendix C- 9 ILLUSTRATION: On January 2, 2010, Tomalczyk borrows $20,000 for 3 years at a rate of 7% per year. Calculate the total interest cost for all three years, assuming interest is compounded annually. Nature of Interest - Compound Interest SO 1 Distinguish between simple and compound interest.

Appendix C- 10 SO 2 Identify the variables fundamental to solving present value problems. The present value is the value now of a given amount to be paid or received in the future, assuming compound interest. Present value variables: 1.Dollar amount to be received in the future, 2.Length of time until amount is received, and 3.Interest rate (the discount rate). Present Value Variables

Appendix C- 11 PV = FV / (1 + i ) n PV = present value of a single amount FV = future value of a single amount p = principal (or present value) i = interest rate for one period n = number of periods Present Value of a Single Amount SO 3 Solve for present value of a single amount. Illustration C-3 Formula for present value

Appendix C- 12 SO 3 Solve for present value of a single amount. Multiply the present value factor by the future value. Illustration: Exercise: Itzak Perlman needs $20,000 in 4 years. What amount must he invest today if his investment earns 12% compounded annually? Present Value of a Single Amount

Appendix C- 13 Exercise: Itzak Perlman needs $20,000 in 4 years. What amount must he invest today if his investment earns 12% compounded annually? Present Value? What table do we use? Future Value $20,000 SO 3 Solve for present value of a single amount. Present Value of a Single Amount

Appendix C- 14 Table 1 What factor do we use? SO 3 Solve for present value of a single amount. Present Value of a Single Amount

Appendix C- 15 Table 1 $20,000 x = $12,710 Future ValueFactorPresent Value SO 3 Solve for present value of a single amount. Present Value of a Single Amount

Appendix C- 16 Exercise: Itzak Perlman needs $20,000 in 4 years. What amount must he invest today if his investment earns 12% compounded quarterly? Present Value? What table do we use? Future Value $20,000 SO 3 Solve for present value of a single amount. Present Value of a Single Amount

Appendix C- 17 Table 1 What factor do we use? SO 3 Solve for present value of a single amount. Present Value of a Single Amount

Appendix C- 18 Table 1 $20,000 x = $12,463 Future ValueFactorPresent Value SO 3 Solve for present value of a single amount. Present Value of a Single Amount

Appendix C- 19 The value now of a series of future receipts or payments, discounted assuming compound interest. 01 Present Value $100,000100, ,000 SO 4 Solve for present value of an annuity. Present Value of an Annuity

Appendix C- 20 Jaime Yuen wins $2,000,000 in the state lottery. She will be paid $100,000 at the end of each year for the next 20 years. What is the present value of her winnings? Assume an appropriate interest rate of 8%. 01 Present Value What table do we use? $100,000100, ,000 SO 4 Solve for present value of an annuity. Present Value of an Annuity

Appendix C- 21 Table 2 What factor do we use? SO 4 Solve for present value of an annuity. Present Value of an Annuity

Appendix C- 22 Table 2 $100,000 x = $981,815 ReceiptFactorPresent Value SO 4 Solve for present value of an annuity. Present Value of an Annuity

Appendix C- 23 SO 5 Compute the present value of notes and bonds. Two Cash Flows: Periodic interest payments (annuity). Principal paid at maturity (single-sum) ,000 $70, ,000 1,000,000 Present Value of a Long-term Note or Bond

Appendix C- 24 Exercise: Arcadian Inc. issues $1,000,000 of 7% bonds due in 10 years with interest payable at year-end. The current market rate of interest for bonds is 8%. What amount will Arcadian receive when it issues the bonds? 01 Present Value ,000 $70, ,0001,070,000 SO 5 Compute the present value of notes and bonds. Present Value of a Long-term Note or Bond

Appendix C- 25 Table 2 $70,000 x = $469,706 Interest PaymentFactorPresent Value PV of Interest SO 5 Compute the present value of notes and bonds. Present Value of a Long-term Note or Bond

Appendix C- 26 Table 1 $1,000,000 x = $463,190 Principal PaymentFactorPresent Value PV of Principal SO 5 Compute the present value of notes and bonds. Present Value of a Long-term Note or Bond

Appendix C- 27 Exercise: Arcadian Inc. issues $1,000,000 of 7% bonds due in 10 years with interest payable at year-end. Present value of Interest $469,706 Present value of Principal 463,190 Bond current market value $932,896 SO 5 Compute the present value of notes and bonds. Present Value of a Long-term Note or Bond

Appendix C- 28 “Copyright © 2009 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.” CopyrightCopyright