1. 1 Time Value of Money Concepts Sid Glandon, DBA, CPA Associate Professor of Accounting

2. 2 Accounting Measurements using Present Value Concepts Notes Leases Amortization of premiums and discounts Pensions and other postretirement benefits Long-term assets Sinking funds Business combinations Disclosures Installment contracts

3. 3 Variables in Interest Computation Principal Amount borrowed or invested Interest rate Percentage applied to outstanding principal Time Number of periods that the principal is outstanding

4. 4 Components of Interest Pure (risk free) rate (2%-4%) Credit risk rate (0%-5%) Expected inflation (0%-?)

5. 5 Simple Interest Interest = p * i * n p=principal i=rate of interest for a single period n=number of periods

6. 6 Example: Simple Interest

7. 7 Compound Interest Computed on Principal balance, plus Accumulated interest not withdrawn

8. 8 Example: Compound Interest

9. 9 Interest Rates Frequency of Compounding Interest rate of 12% per year: Annual Compounded once per year at 12% Semi-annual Compounded twice per year at 6% Quarterly Compounded four times per year at 3% Monthly Compounded twelve times per year at 1%

10. 10 Compound Interest Tables Future value of $1 Present value of $1 Future value of ordinary annuity of $1 Present value of ordinary annuity of $1 Future value of annuity due of $1 Present value of annuity due of $1

11. 11 Annuity Computations Requires that Periodic payments or receipts always be of the same amount Interval between payments or receipts be the same Interest be compounded once each interval

12. 12 Ordinary Annuities Payments or receipts are always made at the end of the period Use the FVOA or PVOA tables

13. 13 Annuity Due Payments or receipts are always made at the beginning of the period Multiply 1 plus the interest rate times the table value of an ordinary annuity

14. 14 Future Value of $1

15. 15 Present Value of $1

16. 16 Future Value of Ordinary Annuity

17. 17 Present Value of Ordinary Annuity

18. 18 Future Value of Annuity Due

19. 19 Present Value of Annuity Due

20. 20 Issue Price of Bonds PV of Principal Using market rate of interest PV of Annuity Annuity = Principal times stated interest rate Using market rate of interest Equals Issue Price of Bonds

21. 21 Fact Pattern: Issue Price of Bonds Face Amount, $100,000 Stated interest rate, 8% Length of bonds, 10 years Interest payments, semi-annual Market interest rate, 10%

22. 22 Issue Price of Bonds