ADMAS UNIVERSITY

Department of Accounting and Finance

Recognition of Accounting

Submitted by Abdurrahman Esmaeal

ID :- ADMA/1441/21

Submitted To Mr. Leake Seyfe

Jan 12 2023
1.What is time value of money?

A significant part of accounting is measurement. In accounting (and finance), the phrase time value of
money indicates a relationship between time and money—that a dollar(birr)received today is worth more
than a dollar(birr) promised at some time in the future. Why? Because of the opportunity to invest today’s
dollar(birr) and receive interest on the investment. Yet, when deciding among investment or borrowing
alternatives, it is essential to be able to compare today’s dollar(birr)and tomorrow’s dollar(birr) on the
same footing—to “compare apples to apples.” Investors do that by using the concept of present value,
which has many applications in accounting.

The basic principle of the time value of money is that money is worth more in the present than it is in the
future, because money you have now has the potential to earn. This is due largely in part to inflation. If
you think about it, $1,000 in 1999 could buy you more than it could 20 years later, in 2019. And having a
$1,000 today will theoretically buy you more than having $1,000 five years from now. With that in mind,
the time value of money formula can help you determine the present value of the money you have today
and how much it could be worth in the future. With investing, there is a certain amount of risk you should
consider as you calculate the time value of money. For example, taking $1,000 and investing it in a
company that is expected to earn 5% per year is not guaranteed. The more risk you take, the more you
are compensated for that risk. In other words, you are accepting the risk of losing money for the chance
to beat inflation and increase the future value of your money.

"Putting it in simple terms, the value of one birr today is not the same after a year. "

2.why does money have time value?

Positive interest rates indicate that money has time value. When one person lets another borrow money,
the first person requires compensation in exchange for reducing current consumption.

This is true because money that you have right now can be invested and earn a return, thus creating a
larger amount of money in the future. (Also, with future money, there is the additional risk that the money
may never actually be received, for one reason or another). The time value of money is sometimes
referred to as the net present value (NPV) of money.
Money has a time value i.e. a Birr today is worth more than a Birr tomorrow, which is expressed in terms
of interest charges. Since the use of money bears the cost of interest, management must optimize the use
the employment of investable money (funds); it must choose a wide array of investment opportunities and
choose the one which is most profitable.

The time value of money is important because it allows investors to make a more informed decision about
what to do with their money. The TVM can help you understand which option may be best based on
interest, inflation, risk and return. It can also be used to help you understand how much money to save in
an account if you have a certain goal in mind, such as saving $20,000 in five years if the account earns 3
percent compound interest each year.

3.what is compound interest ? Compare compound interest to discounting ?

Time Value of Money says that the worth of a unit of money is going to be changed in future. Put simply,
the value of one rupee today will be decreased in future. The whole concept is about the present value and
future value of money. There are two methods used for ascertaining the worth of money at different
points of time, namely, compounding and discounting. Compounding method is used to know the future
value of present money. Conversely, discounting is a way to compute the present value of future money.

Compounding is helpful to know the future values, of the cash flow, at the end of the particular period, at
a definite rate. Contrary to this, Discounting is used to determine the present value of the future cash flow,
at a certain interest rate. Here, in this article, we’ve described the differences between compounding and
discounting.
4.How is present value affected by a change in discount rate ?

The present value refers to the amount of money you would need to invest today in order to receive the
annuity's promised income stream in the future. The discount rate is one factor that can affect the present
value of an annuity. This rate, which may also be referred to as the interest rate, has an inverse effect on
your present value — the higher the discount rate, the lower the present value. The discount rate is the
investment rate of return that is applied to the present value calculation. In other words, the discount rate
would be the forgone rate of return if an investor chose to accept an amount in the future versus the same
amount today.

The discount rate that is chosen for the present value calculation is highly subjective because it's the
expected rate of return you'd receive if you had invested today's dollars for a period of time.The discount
rate is the investment rate of return that is applied to the present value calculation. In other words, the
discount rate would be the forgone rate of return if an investor chose to accept an amount in the future
versus the same amount today. The discount rate that is chosen for the present value calculation is highly
subjective because it's the expected rate of return you'd receive if you had invested today's dollars for a
period of time.

5. What is annunity ?

Annuity refers to a sequence or series of equal periodic payments, deposits, withdrawals, or receipts made
at equal intervals for a specified number of periods. For instance, regular deposits to a saving account,
monthly expenditures for car rent, insurance, house rent expenses, and periodic payments to a person
from a retirement plan fund are some of particular examples of annuity. Payments of any type are
considered as annuities if all of
the following conditions are present:
 i. The periodic payments are equal in amount
ii. The time between payments is constant such as a year, half a year, a quarter of a year, a month
etc.
iii. The interest rate per period remains constant.
iv. The interest is compounded at the end of every time.

Annuities are classified according to the time the payment is made. Accordingly, we have two basic
types of annuities.
I. Ordinary annuity: is a series of equal periodic payment is made at the end of each interval or period.
In this case, the last payment does not earn interest.

II. Annuity due: is a type of annuity for which a payment is made of the beginning of each interval or
period.

6. How does continues compounding benefit an inverter ?

Continuous compounding is the mathematical limit that compound interest can reach if it's calculated and
reinvested into an account's balance over a theoretically infinite number of periods. While this is not
possible in practice, the concept of continuously compounded interest is important in finance. It is an
extreme case of compounding, as most interest is compounded on a monthly, quarterly, or semiannual
basis. Instead of calculating interest on a finite number of periods, such as yearly or monthly, continuous
compounding calculates interest assuming constant compounding over an infinite number of periods. The
formula for compound interest over finite periods of time takes into account four variables:

The formula for continuous compounding is derived from the formula for the future value of an interest-
bearing investment:

Future Value (FV) = PV x [1 + (i / n)](n x t)

Where

PV = the present value of the investment

i = the stated interest rate

n = the number of compounding periods

t = the time in years

Calculating the limit of this formula as n approaches infinity (per the definition of continuous
compounding) results in the formula for continuously compounded interest:

FV = PV x e (i x t), where e is the mathematical constant approximated as 2.7183.

7.What formula would you use to solve for payment required for a car loan if you know the
interstate rate, length of the loan, and the borrowed amount ? Explain .

To calculate your monthly car loan payment by hand, divide the total loan and interest amount by the loan
term (the number of months you have to repay the loan).

Where,

M=monthly principal and interest payment

P=loan Amount

I=interest rate

L=length of lone

Problems

1.Meron has just taken out a bank loan for $12,000 which will be paid back monthly over a 3 year
period. If the annual interest rate is 8% compounded monthly, what are her monthly loan
payments?
2.Samrawit is saving for a car that she wishes to purchase from her Uncle in 5 years. Her Uncle has
promised to sell her the car for $7,000 at that time. How much does Samrawit have to put in her
savings account at the beginning of each year if her account receives interest of 5% annually? Her
deposits will start tomorrow and will continue annually until the beginning of the 5th year.

3.Mr. and Mrs. Mikihazemed would like to buy an annuity that will pay for their son’s university
education. They believe an annuity that pays $5,000 every six months for four years will be
adequate. Their son is in junior high school, so they will not need any money from the annuity until
the start of the 6th. Year. The interest rate available for the annuity is 7% annually. How much will
they pay today for the annuity?

Solution

4.NEBIR BANK’s preferred shares have a par value of $2,500 and pay an annual dividend of $200.
The current required rate is 6.42%. What is the current price of the shares?

Solution

PV of preferred stock; Po=Dp/rp

Po=200/0.0642

PV of preferred stock (Po) =3115.26

5.Find the future value of an annuity of $600 per year for 4 years if the interest rate is 19 per cent.

Solution

FV of Annuity=p[((1+i)n-1)/i]

FV=600[((1+0.19)4-1)/0.19]

Future value of Annuity (FV)=3174.7554

6.Find the future value at the end of 9 years of $500 invested today at an interest rate of 8 percent.

Solution

FV = PV(1+r)^t

FV = 500(1+8%)^9

Fv =500* 1.999

FV= 999.50

7.Find the present value of the following cash flow stream if the interest rate is 16 per cent.

Solution

PV= sum of (FVn/(1+i)n)

8.Find the present value of the following cash flow stream if the interest rate is 19 per cent.

Solution

9.You want to buy an ordinary annuity that will pay you $4,000 a year for the next 20 years. You
expect annual interest rates will be 8 percent over that time period. The maximum price you would
be willing to pay for the annuity is closest to

Solution

PV=P×(1-(1+r)^(-n))/r

PV=4000×(1-(1+0.08)^(-20))/0.08

percent payment for the annuity (PA) =39,272.59

10.In 3 years you are to receive $5,000. If the interest rate were to suddenly increase, the present
value of that future amount to you would

A.Fall.

B.Rise.

C.Remain unchanged.

D.Cannot be determined without more information.

The present value of a future cash flow is mathematically calculated as:calculated

The interest rate is also called the discount rate because it is used to discount the future cash flows
to calculate their present values. So, the higher the discount rate, the lower will be the present
value. Therefore, the correct answer is A

11.Assume that the interest rate is greater than zero. Which of the following cash-inflow streams

should you prefer?

The answer is A because of time value of money, more the amount received today or in initial year
will be preferred.
12.You are considering borrowing $10,000 for 3 years at an annual interest rate of 6%. The loan
agreement calls for 3 equal payments, to be paid at the end of each of the next 3 years. (Payments
include both principal and interest.) The annual payment that will fully pay off (amortize) the loan
is closest to

Solution