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Oct 22, 2013

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Chapter 6: The Time Value of Money

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Chapter 6: The Time Value of Money

Attribution Non-Commercial (BY-NC)

- Principles: Life and Work
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AACSB assurance of learning standards in accounting and business education require documentation of outcomes assessment. Although schools, departments, and faculty may approach assessment and its documentation differently, one approach is to provide specific questions on exams that become the basis for assessment. To aid faculty in this endeavor, we have labeled each question, exercise, and problem in Intermediate Accounting, 7e, with the following AACSB learning skills: Questions

61 62 63 64 65 66 67 68 69 610 611 612 613 614 615

AACSB Tags

Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Analytic Analytic Reflective thinking Reflective thinking Analytic Reflective thinking, Communications Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic

Exercises (cont.)

69 610 611 612 613 614 615 616 617 618 619 620 621

AACSB Tags

Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Reflective thinking Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Reflective thinking Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic

CPA/CMA

1 2 3 4 5 6 7 1 2

Brief Exercises

61 62 63 64 65 66 67 68 69 610 611 612 613

Problems

61 62 63 64 65 66 67 68 69 610 611 612 613 614 615

Exercises

61 62 63 64 65 66 67 68

Question 61

Interest is the amount of money paid or received in excess of the amount borrowed or lent.

Question 6-2

Compound interest includes interest not only on the original invested amount but also on the accumulated interest from previous periods.

Question 63

If interest is compounded more frequently than once a year, the effective rate or yield will be higher than the annual stated rate.

Question 64

The three items of information necessary to compute the future value of a single amount are the original invested amount, the interest rate (i), and the number of compounding periods (n).

Question 65

The present value of a single amount is the amount of money today that is equivalent to a given amount to be received or paid in the future.

Question 66

Monetary assets and monetary liabilities represent cash or fixed claims/commitments to receive/pay cash in the future and are valued at the present value of these fixed cash flows. All other assets and liabilities are nonmonetary.

Question 67

An annuity is a series of equal-sized cash flows occurring over equal intervals of time.

Question 68

An ordinary annuity exists when the cash flows occur at the end of each period. In an annuity due the cash flows occur at the beginning of each period.

Question 69

Table 2 lists the present value of $1 factors for various time periods and interest rates. The factors in Table 4 are simply the summation of the individual PV of $1 factors from Table 2.

Present Value ? 0

Year 1

Year 2

Year 3

Year 4

___________________________________________

$200

$200

Question 611

Present Value ? 0

Year 1

Year 2

Year 3

Year 4

___________________________________________

$200

$200

Question 612

A deferred annuity exists when the first cash flow occurs more than one period after the date the agreement begins.

Question 613

The formula for computing present value of an ordinary annuity incorporating the ordinary annuity factors from Table 4 is: PVA = Annuity amount x Ordinary annuity factor Solving for the annuity amount, PVA Annuity amount = Ordinary annuity factor The annuity factor can be obtained from Table 4 at the intersection of the 8% column and 5 period row.

Question 614

Annuity amount = Annuity amount = $500 3.99271 $125.23

Companies frequently acquire the use of assets by leasing rather than purchasing them. Leases usually require the payment of fixed amounts at regular intervals over the life of the lease. Certain leases are treated in a manner similar to an installment sale by the lessor and an installment purchase by the lessee. In other words, the lessor records a receivable and the lessee records a liability for the several installment payments. For the lessee, this requires that the leased asset and corresponding lease liability be valued at the present value of the lease payments.

BRIEF EXERCISES

Brief Exercise 61

Fran should choose the second investment opportunity. More rapid compounding has the effect of increasing the actual rate, which is called the effective rate, at which money grows per year. For the second opportunity, there are four, three-month periods paying interest at 2% (one-quarter of the annual rate). $10,000 invested will grow to $10,824 ($10,000 x 1.0824*). The effective annual interest rate, often referred to as the annual yield, is 8.24% ($824 $10,000), compared to just 8% for the first opportunity.

* Future value of $1: n = 4, i = 2% (from Table 1)

Brief Exercise 62

Bill will not have enough accumulated to take the trip. The future value of his investment of $23,153 is $347 short of $23,500. FV = $20,000 (1.15763* ) = $23,153

* Future value of $1: n = 3, i = 5% (from Table 1)

Brief Exercise 63

FV factor = $26,600 = 1.33* $20,000

Brief Exercise 64

John would be willing to invest no more than $12,673 in this opportunity. PV = $16,000 (.79209* ) = $12,673

* Present value of $1: n = 4, i = 6% (from Table 2)

Brief Exercise 65

PV factor = $13,200 = .825* $16,000

The McGraw-Hill Companies, Inc., 2013 65

Brief Exercise 66

Interest is paid for 12 periods at 1% (one-quarter of the annual rate). FVA = $500 (12.6825* ) = $6,341

Brief Exercise 67

Interest is paid for 12 periods at 1% (one-quarter of the annual rate). FVAD = $500 (12.8093* ) = $6,405

Brief Exercise 68

PVA = $10,000 (4.10020* ) = $41,002

* Present value of an ordinary annuity of $1: n =5, i = 7% (from Table 4)

Brief Exercise 69

PVAD = $10,000 (4.38721*) = $43,872

* Present value of an annuity due of $1: n = 5, i = 7% (from Table 6)

PVA = $10,000 x 4.10020* .87344* = $41,002

* Present value of an ordinary annuity of $1: n = 5, i = 7% (from Table 4)

PV

= $41,002

$35,813

Or alternatively: From Table 4, PVA factor, n = 7, i = 7% PVA factor, n = 2, i = 7% = PV factor for deferred annuity

The McGraw-Hill Companies, Inc., 2013 66 Intermediate Accounting, 7/e

Annuity = $100,000 = $14,903 = Payment 6.71008*

PV = $6,000,0001 (12.40904* ) + 100,000,000 (.13137** ) PV = $74,454,240 + 13,137,000 = $87,591,240 = price of the bonds

1

$100,000,000 x 6% = $6,000,000 * Present value of an ordinary annuity of $1: n = 30, i = 7% (from Table 4) ** Present value of $1: n = 30, i = 7% (from Table 2)

PVAD = $55,000 (7.24689* ) = $398,579 = Liability

* Present value of an annuity due of $1: n = 10, i = 8% (from Table 6)

EXERCISES

Exercise 61

1. FV = $15,000 (2.01220* ) = $30,183

* Future value of $1: n = 12, i = 6% (from Table 1)

* Future value of $1: n = 10, i = 8% (from Table 1)

* Future value of $1: n = 20, i = 12% (from Table 1)

* Future value of $1: n = 12, i = 4% (from Table 1)

Exercise 62

1. FV = $10,000 (2.65330* ) = $26,533

* Future value of $1: n = 20, i = 5% (from Table 1)

* Future value of $1: n = 20, i = 3% (from Table 1)

* Future value of $1: n = 30, i = 2% (from Table 1)

Exercise 63

1. PV = $20,000 (.50835* ) = $10,167

* Present value of $1: n = 10, i = 7% (from Table 2)

* Present value of $1: n = 12, i = 8% (from Table 2)

* Present value of $1: n = 20, i = 12% (from Table 2)

* Present value of $1: n = 8, i = 10% (from Table 2)

Exercise 64

First payment: Second payment Third payment Fourth payment Payment $5,000 6,000 8,000 9,000 Total x x x x PV of $1 i=8% .92593 .85734 .73503 .63017 = = = = PV $ 4,630 5,144 5,880 5,672 $21,326 n 1 2 4 6

Exercise 65

PV = $85,000 (.82645* ) = $70,248 = Note/revenue

* Present value of $1: n = 2, i = 10% (from Table 2)

Exercise 66

1. PV = $40,000 (.62092* ) = $24,837

* Present value of $1: n = 5, i = 10% (from Table 2)

2.

$36,289 $65,000

.55829*

3.

$15,884 $40,000

.3971*

4.

$46,651 = $100,000

.46651*

5.

Exercise 67

1. FVA = $2,000 (4.7793* ) = $9,559

* Future value of an ordinary annuity of $1: n = 4, i = 12% (from Table 3)

2. 3.

x x x x

= = = =

n 16 12 8 4

$2,000 x 4 = $8,000

Exercise 68

1. PVA = $5,000 (3.60478* ) = $18,024

* Present value of an ordinary annuity of $1: n = 5, i = 12% (from Table 4)

2. 3.

= $20,187

First payment: Second payment Third payment Fourth payment Fifth payment

x x x x x

= = = = =

n 4 8 12 16 20

Exercise 69

1. 2. PVA = $3,000 (3.99271* ) = $11,978 $242,980 = $75,000 3.23973*

* Present value of an ordinary annuity of $1: n = 5, i = 8% (from Table 4)

3.

$161,214 = $20,000

8.0607*

4.

$500,000 = $80,518

6.20979*

5.

$250,000 = 3.16987*

$78,868

Exercise 610

Requirement 1

* Present value of $1: n = 5, i = 8% (from Table 2)

* Future value of an ordinary annuity of $1: n = 5, i = 8% (from Table 3)

Annuity amount

= $17,046

* Future value of an annuity due of $1: n = 5, i = 8% (from Table 5)

Exercise 611

1. Choose the option with the highest present value. (1) PV = $64,000 (2) PV = $20,000 + 8,000 (4.91732* )

* Present value of an ordinary annuity of $1: n = 6, i = 6% (from Table 4)

PV = $20,000 + 39,339 = $59,339 (3) PV = $13,000 (4.91732* ) = $63,925 Alex should choose option (1).

* Future value of an ordinary annuity of $1: n = 10, i = 7% (from Table 3)

Exercise 612

PVA = $5,000 x 4.35526* = $21,776

* Present value of an ordinary annuity of $1: n = 6, i = 10% (from Table 4)

PV

= $21,776

.82645*

$17,997

Or alternatively: From Table 4, PVA factor, n = 8, i = 10% PVA factor, n = 2, i = 10% = PV factor for deferred annuity PV = $5,000 x 3.59939 = $17,997

= = =

Exercise 613

Annuity = $20,000 5,000 = $670 = Payment 22.39646*

* Present value of an ordinary annuity of $1: n = 30, i = 2% (from Table 4)

Exercise 614

PVA factor = $100,000 = 7.46938* $13,388

* Present value of an ordinary annuity of $1: n = 20, i = ? (from Table 4, i = approximately 12%)

Exercise 615

Annuity = $12,000 = $734 = Payment

16.35143*

* Present value of an ordinary annuity of $1: n = 20, i = 2% (from Table 4)

5 years x 4 quarters = 20 periods 8% 4 quarters = 2%

Exercise 616

PV PV = = ? x .90573* $1,325 = 1,200 $1,200 = .90573*

PVA = PVA =

?

annuity amount

14.99203* $88 =

= Payment

$1,325

$1,325 = 14.99203*

Exercise 617

To determine the price of the bonds, we calculate the present value of the 40period annuity (40 semiannual interest payments of $12 million) and the lump-sum payment of $300 million paid at maturity using the semiannual market rate of interest of 5%. In equation form,

PV = $12,000,0001 (17.15909* ) + 300,000,000 (.14205** ) PV = $205,909,080 + 42,615,000 = $248,524,080 = price of the bonds

$300,000,000 x 4 % = $12,000,000 * Present value of an ordinary annuity of $1: n = 40, i = 5% (from Table 4) ** Present value of $1: n = 40, i = 5% (from Table 2)

1

Exercise 618

Requirement 1 To determine the price of the bonds, we calculate the present value of the 30period annuity (30 semiannual interest payments of $6 million) and the lump-sum payment of $200 million paid at maturity using the semiannual market rate of interest of 2.5%. In equation form, PV = $6,000,0001 (20.93029* ) + 200,000,000 (.47674) PV = $125,581,740 + 95,348,000 = $220,929,740 = price of the bonds

$200,000,000 x 3 % = $6,000,000 * Present value of an ordinary annuity of $1: n = 30, i = 2.5% (from Table 4) ** Present value of $1: n = 30, i = 2.5% (from Table 2)

1

Requirement 2 $220,929,740 x 2.5% = $5,523,244 Because the bonds were outstanding only for six months of the year, Singleton reports only one-half years interest in 2013.

Exercise 619

Requirement 1 PVA = $400,000 (10.59401* ) = $4,237,604 = Liability

* Present value of an ordinary annuity of $1: n = 20, i = 7% (from Table 4)

* Present value of an annuity due of $1: n = 20, i = 7% (from Table 6)

Exercise 620

PVA factor = $2,293,984 = 11.46992* $200,000

* Present value of an ordinary annuity of $1: n = 20, i = ? (from Table 4, i = 6%)

The McGraw-Hill Companies, Inc., 2013 617

Exercise 621

List A e 1. Interest List B

m 2. j i k l c d a 3. 4. 5. 6. 7. 8. 9.

a. First cash flow occurs one period after agreement begins. Monetary asset b. The rate at which money will actually grow during a year. Compound interest c. First cash flow occurs on the first day of the agreement. Simple interest d. The amount of money that a dollar will grow to. Annuity e. Amount of money paid/received in excess of amount borrowed/lent. Present value of a single f. Obligation to pay a sum of cash, the amount amount of which is fixed. Annuity due g. Money can be invested today and grow to a larger amount. Future value of a single h. No fixed dollar amount attached. amount Ordinary annuity i. Computed by multiplying an invested amount by the interest rate. Effective rate or yield j. Interest calculated on invested amount plus accumulated interest. Nonmonetary asset k. A series of equal-sized cash flows. Time value of money l. Amount of money required today that is equivalent to a given future amount. Monetary liability m. Claim to receive a fixed amount of money.

CPA Exam Questions

1. b. PV = FV x PV factor, PV=$25,458 x 0.3075 = $7,828 2. d. The sales price is equal to the present value of the note payments: Present value of first payment Present value of last six payments: $60,000 x 4.36 Sales price 3. a. PVA = $100 x 4.96764 = $497 4. b. First solve for present value of a four-year ordinary annuity: PVA = $100 x 3.03735 = $304 Then discount back two years: PV = $304 x 0.79719 = $242 5. d. PVAD = $100,000 x 9.24424 = $924,424 6. a. PVA = $100 x 5.65022 = $565 (present value of the interest payments) PV = $1,000 x 0.32197 = $322 (present value of the face amount) Total present value = $887 = current market value of the bond 7. a. PVA = PMT x PVA factor $15,000 = PMT x 44.955 PMT = $334 $ 60,000 261,600 $321,600

1. d. Both future value tables will be used because the $75,000 already in the account will be multiplied times the future value factor of 1.26 to determine the amount three years hence, or $94,500. The three payments of $4,000 represent an ordinary annuity. Multiplying the three-period annuity factor (3.25) by the payment amount ($4,000) results in a future value of the annuity of $13,000. Adding the two elements together produces a total account balance of $107,500. 2. a. An annuity is a series of cash flows or other economic benefits occurring at fixed intervals, ordinarily as a result of an investment. Present value is the value at a specified time of an amount or amounts to be paid or received later, discounted at some interest rate. In an annuity due, the payments occur at the beginning, rather than at the end, of the periods. Thus, the present value of an annuity due includes the initial payment at its undiscounted amount. This lease should be evaluated using the present value of an annuity due.

PROBLEMS

Problem 61

Choose the option with the lowest present value of cash outflows, net of the present value of any cash inflows (Cash outflows are shown as negative amounts; cash inflows as positive amounts). Machine A: PV = $48,000 1,000 (6.71008* ) + 5,000 (.46319** )

* Present value of an ordinary annuity of $1: n = 10, i = 8% (from Table 4) ** Present value of $1: n = 10, i = 8% (from Table 2)

PV = $48,000 6,710 + $2,316 PV = $52,394 Machine B: PV = $40,000 4,000 (.79383) 5,000 (.63017) 6,000 (.54027)

PV of $1: i = 8% (from Table 2) n=3

n=6

n=8

Problem 62

1. PV = $10,000 + 8,000 (3.79079* ) = $40,326 = Equipment

* Present value of an ordinary annuity of $1: n = 5, i = 10% (from Table 4)

* Future value of an annuity due of $1: n = 5, i = 6% (from Table 5)

Annuity amount = $400,000 5.9753 Annuity amount = $66,942 = Required annual deposit

* Present value of an annuity due of $1: n = 20, i = 10% (from Table 6)

Solutions Manual, Vol.1, Chapter 6 The McGraw-Hill Companies, Inc., 2013 621

Problem 63

Choose the option with the lowest present value of cash payments.

1. PV = $1,000,000 2. PV = $420,000 + 80,000 (6.71008* ) = $956,806

* Present value of an ordinary annuity of $1: n = 10, i = 8% (from Table 4)

* Present value of an annuity due of $1: n = 10, i = 8% (from Table 6)

* Present value of $1: n = 5, i = 8% (from Table 2)

Problem 64

The restaurant should be purchased if the present value of the future cash flows discounted at a 10% rate is greater than $800,000.

PV = $80,000 (4.35526* ) + 70,000 (.51316** ) + 60,000 (.46651**)

n=7

n=8

n=9 n = 10

n = 10

* Present value of an ordinary annuity of $1: n = 6, i = 10% (from Table 4) ** Present value of $1: i = 10% (from Table 2)

Since the PV is less than $800,000, the restaurant should not be purchased.

Problem 65

The maximum amount that should be paid for the store is the present value of the estimated cash flows. Years 15: PVA = $70,000

3.99271* =

$279,490

PV

= $265,355

$180,595

PV

= $395,515

$245,583

PV

= $245,583

$167,139

Total PV = $279,490 + 180,595 + 167,139 + 54,424 = The maximum purchase price is $681,648.

$681,648

Problem 66

1. PV of $1 factor = $30,000 = .5000* $60,000

* Present value of $1: n = ?, i = 8% (from Table 2, n = approximately 9 years)

2. PVA Annuity factor = Annuity amount Annuity factor = $28,700 = 4.1000* $7,000

* Present value of an ordinary annuity of $1: n = 5, i = ? (from Table 4, i = approximately 7%)

3. PVA Annuity amount = Annuity factor Annuity amount = $10,000 = 6.41766* $1,558 = Payment

Problem 67

Requirement 1 PVA Annuity amount = Annuity factor Annuity amount = $250,000 = $78,868 = Payment 3.16987*

* Present value of an ordinary annuity of $1: n = 4, i = 10% (from Table 4)

Requirement 2 PVA Annuity amount = Annuity factor Annuity amount = $250,000 = $62,614 = Payment 3.99271*

* Present value of an ordinary annuity of $1: n = 5, i = 8% (from Table 4)

Requirement 3 PVA Annuity factor = Annuity amount Annuity factor = $250,000 = 4.86845* $51,351

* Present value of an ordinary annuity of $1: n = ?, i = 10% (from Table 4, n = approximately 7 payments)

Requirement 4 PVA Annuity factor = Annuity amount Annuity factor = $250,000 = 2.40184* $104,087

* Present value of an ordinary annuity of $1: n = 3, i = ? (from Table 4, i = approximately 12%)

Problem 68

Requirement 1 Present value of payments 46: PVA = $40,000 x 2.48685* .75131* = $99,474

PV

= $99,474

$74,736

$ 62,171 (PV of payments 13: $25,000 x 2.48685* )

74,736 (PV of payments 46 calculated above) $136,907 The note payable and corresponding building should be recorded at $136,907. Or alternatively:

* Present value of an ordinary annuity of $1: n = 3, i = 10% (from Table 4)

From Table 4, PVA factor, n = 6, i = 10% PVA factor, n = 3, i = 10% = PV factor for deferred annuity Requirement 2

Problem 69

Choose the alternative with the highest present value. Alternative 1: PV = $180,000 Alternative 2: PV = PVAD = $16,000 (11.33560* ) = $181,370

* Present value of an annuity due of $1: n = 20, i = 7% (from Table 6)

PV

= $351,179

$191,017

John should choose alternative 3. Or, alternatively (for 3): PV = $50,000 (3.82037* ) = $191,019

(difference due to rounding)

From Table 4, PVA factor, n = 19, i = 7% PVA factor, n = 9, i =7% = PV factor for deferred annuity or, From Table 6, PVAD factor, n = 20, i = 7% PVAD factor, n = 10, i = 7% = PV factor for deferred annuity

Solutions Manual, Vol.1, Chapter 6

The McGraw-Hill Companies, Inc., 2013 627

Problem 610

PV = $20,000 (3.79079* ) + 100,000 (.62092** ) = $137,908

* Present value of an ordinary annuity of $1: n = 5, i = 10% (from Table 4) ** Present value of $1: n = 5, i = 10% (from Table 2)

Problem 611

Requirement 1 PVAD = Annuity amount x Annuity factor PVAD Annuity amount = Annuity factor Annuity amount = $800,000 7.24689*

* Present value of an annuity due of $1: n = 10, i = 8% (from Table 6)

Annuity amount = $110,392 = Lease payment Requirement 2 Annuity amount = $800,000 6.71008*

* Present value of an ordinary annuity of $1: n = 10, i = 8% (from Table 4)

Annuity amount = $119,224 = Lease payment Requirement 3 PVAD = (Annuity amount x Annuity factor) + PV of residual Annuity amount = PVAD PV of residual Annuity factor x .46319* = $23,160

PV of residual = $50,000

* Present value of an annuity due of $1: n = 10, i = 8% (from Table 6)

Problem 612

Requirement 1 PVA = Annuity amount x Annuity factor PVA Annuity amount = Annuity factor Annuity amount = $800,000 7.36009*

* Present value of an ordinary annuity of $1: n = 10, i = 6% (from Table 4)

Annuity amount = $108,694 = Lease payment Requirement 2 Annuity amount = $800,000 15.32380*

* Present value of an annuity due of $1: n = 20, i = 3% (from Table 6)

Annuity amount = $52,206 = Lease payment Requirement 3 Annuity amount = $800,000 44.9550*

* Present value of an ordinary annuity of $1: n = 60, i = 1% (given)

Problem 613

Choose the option with the lowest present value of cash outflows, net of the present value of any cash inflows. (Cash outflows are shown as negative amounts; cash inflows as positive amounts) 1. Buy option: PV = $160,000 5,000 (5.65022* ) + 10,000 (.32197** )

* Present value of an ordinary annuity of $1: n = 10, i = 12% (from Table 4) ** Present value of $1: n = 10, i = 12% (from Table 2)

PV = $160,000 28,251 + 3,220 PV = $185,031 2. Lease option: PVAD = $25,000 (6.32825* ) = $158,206

* Present value of an annuity due of $1: n = 10, i = 12% (from Table 6)

Problem 614

Requirement 1 Tinkers: PVA = $20,000 x 7.19087* .81162* = $143,817

PV

= $143,817

$116,725

PV

= $179,772

$131,447

* Present value of an ordinary annuity of $1: n = 15, i = 11% (from Table 4)

PV

= $215,726

$142,105

Deferred annuity factor 5.83627 5.25791 4.73684

Problem 614 (concluded) Present value of pension obligations at 12/31/13: Tinkers: $20,000 x 5.83627 = $116,725 Evers: $25,000 x 5.25791 = $131,448* Chance: $30,000 x 4.73684 = $142,105 *rounding difference Requirement 2 Present value of pension obligations as of December 31, 2016:

Employee Tinkers Evers Chance PV as of 12/31/13 $116,725 131,448 142,105 x FV of $1 factor, n = 3, i = 11% 1.36763 x 1.36763 x 1.36763 x Total present value, 12/31/16 = = = = FV as of 12/31/16 $159,637 179,772 194,347 $533,756

FVAD = Annuity amount x Annuity factor FVAD Annuity amount = Annuity factor Annuity amount = $533,756 = 3.7097* $143,881

Problem 615

Bond liability: PV = $4,000,0001 (18.40158* ) + 100,000,000 (.17193** ) PV = $73,606,320 + 17,193,000 = $90,799,320 = Initial bond liability

$100,000,000 x 4 % = $4,000,000 * Present value of an ordinary annuity of $1: n = 40, i = 4.5% (from Table 4) ** Present value of $1: n = 40, i = 4.5% (from Table 2)

1

* Present value of an annuity due of $1: n = 20, i = 10% (from Table 6)

* Present value of an annuity due of $1: n = 17, i = 10% (from Table 6)

PV

* Present value of an ordinary annuity of $1: n = 17, i = 10% (from Table 4)

PV

Or, alternatively for Lease B: PV = $220,000 (6.62938* ) = $1,458,464 (difference due to rounding) = = = 8.36492 1.73554 6.62938*

From Table 4, PVA factor, n = 19, i = 10% PVA factor, n = 2, i = 10% = PV factor for deferred annuity

The companys balance sheet would include a liability for bonds of $90,799,320 and a liability for leases of $3,331,439 ($1,872,984 + $1,458,455).

The McGraw-Hill Companies, Inc., 2013 634 Intermediate Accounting, 7/e

CASES

Ethics Case 61

The ethical issue is that the 21% return implies an annual return of 21% on an investment and misrepresents the funds performance to all current and future stakeholders. Interest rates are usually assumed to represent an annual rate, unless otherwise stated. Interested investors may assume that the return for $100 would be $21 per year, not $21 over two years. The Damon Investment Company ad should explain that the 21% rate represented appreciation over two years.

Analysis Case 62

Sally should choose the alternative with the highest present value. Alternative 1: PV = $50,000 Alternative 2: PV = PVAD = $10,000 (5.21236* ) = $52,124

* Present value of an annuity due of $1: n = 6, i = 6% (from Table 6)

2.67301*

$58,806

PV

$58,806

.89000*

$52,337

Sally should choose alternative 3. Or, alternatively (for 3): PV = $22,000 (2.37897* ) = $52,337 From Table 4, PVA factor, n = 5, i = 6% PVA factor, n = 2, i = 6% = PV factor for deferred annuity or, from Table 6, PVAD factor, n = 6, i = 6% PVAD factor, n = 3, i = 6% = PV factor for deferred annuity due

Communication Case 63

Suggested Grading Concepts and Grading Scheme: Content (65%) ______ 25 Explanation of the method used (present value) to compare the two contracts. ______ 30 Presentation of the calculations. 49ers PV = $6,989,065 Cowboys PV = $6,492,710 ______ 10 Correct conclusion. ____ ______ 65 points Writing (35%) ______ 5 Proper letter format. ______ 6 Terminology and tone appropriate to the audience of a player's agent.

______ 12 Organization permits ease of understanding. ____ Introduction that states purpose. ____ Paragraphs that separate main points. ______ 12 English ____ Sentences grammatically clear and well organized, concise. ____ Word selection. ____ Spelling. ____ Grammar and punctuation. ____ ______ 35 points

Analysis Case 64

The settlement was determined by calculating the present value of lost future income ($200,000 per year) discounted at a rate that is expected to approximate the time value of money. In this case, the discount rate, i, apparently is 7% and the number of periods, n, is 25 (the number of years to Johns retirement). Johns settlement was calculated as follows: $200,000 annuity amount x 11.65358* = $2,330,716

* Present value of an ordinary annuity of $1: n = 25, i = 7% (from Table 4) Note: In the actual case, Johns present salary was increased by 3% per year to reflect future salary increases.

Judgment Case 65

Purchase price of new machine Sales price of old machine Incremental cash outflow required $150,000 (100,000) $ 50,000

The new machine should be purchased if the present value of the savings in operating costs of $8,000 ($18,000 10,000) plus the present value of the salvage value of the new machine exceeds $50,000. PV = ($8,000 x 3.99271* ) + ($25,000 x .68058** ) PV = $31,942 + 17,015 PV = $48,957

* Present value of an ordinary annuity of $1: n = 5, i = 8% (from Table 4) ** Present value of $1: n = 5, i = 8% (from Table 2)

Requirement 1 The effective interest rate can be determined by solving for the unknown present value of $1 factor for 20 semiannual periods (20112020): PV of $1 factor = $ 194 = .71193* $272.5

* Present value of $1: n = 20, i = ? (from Table 2, i = approximately 1.5%)

So, 1.5% is the approximate effective semiannual interest rate. A financial calculator or Excel will produce the same rate. The companys long-term debt disclosure note indicates that the annual rate is 3.0% Requirement 2 Using a 1.5% effective semiannual rate and 40 periods: PV = $1,000 (.55126* ) = $551.26

* Present value of $1: n = 40, i = 1.5% (from Table 2)

Requirement 1 The effective interest rate can be determined by solving for the unknown present value of an ordinary annuity of $1 factor for seven periods: PV of an ordinary annuity of $1 factor = $738 = 4.824* $153

* Present value of an ordinary annuity $1: n = 7, i = ? (from Table 4, i = approximately 10%)

In row 7 of Table 4, the value of 4.86842 is in the 10% column. So, 10% is the approximate effective interest rate. A financial calculator or Excel will produce the same result. Requirement 2 The effective interest rate can be determined by solving for the unknown present value of an annuity due $1 factor for seven periods: PV of an annuity due of $1 factor = $738 = 4.824 $153

In row 7 of Table 6, the value of 5.11141 is in the 12% column. So, the approximate effective interest rate is slightly higher than 12%. A financial calculator or Excel will produce the same result.

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