6-1

CHAPTER 6
Accounting and the Time Value of Money
ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)
Topics Questions
Brief
Exercises Exercises Problems
1. Present value concepts. 1, 2, 3, 4,
5, 9, 17
2. Use of tables. 13, 14 8 1
3. Present and future value
problems:
a. Unknown future amount. 7, 19 1, 5, 13 2, 4, 6, 7, 11
b. Unknown payments. 10, 11, 12 6, 12, 17 7, 16, 17 2, 6
c. Unknown number of
periods.
4, 9 8, 15 2
d. Unknown interest rate. 15, 18 3, 11, 16 7, 9, 14 2, 7
e. Unknown present value. 8, 19 2, 7, 8, 10, 14 2, 3, 4, 5, 6, 8,
12, 17, 18, 19
1, 4, 7, 13, 14
4. Value of a series of
irregular deposits;
changing interest rates.
3, 5, 8
5. Valuation of leases,
pensions, bonds; choice
between projects.
6 15 10, 12, 13,
14, 15
3, 5, 6, 8, 9,
10, 13, 14
6. Deferred annuity. 16 7
7. Expected Cash Flows. 20, 21 13, 14
*8. Uses of a calculator. 22, 23, 24 15, 16, 17
6-2
ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)
Learning Objectives
Brief
Exercises Exercises Problems
1. Identify accounting topics where the time
value of money is relevant.
2. Distinguish between simple and compound
interest.
2
3. Use appropriate compound interest tables. 1
4. Identify variables fundamental to solving
interest problems.
5. Solve future and present value of problems. 1, 2, 3,
4, 7, 8
2, 3, 6, 9,
10, 12, 15,
18, 19
1, 2, 3, 5,
7, 9, 10
6. Solve future value of ordinary and annuity
due problems.
5, 6, 9, 13 3, 4, 5, 6,
12, 15, 16
1, 2, 3, 4, 5,
7, 8, 9, 10
7. Solve present value of ordinary and annuity
due problems.
10, 11, 12,
14, 16, 17
3, 4, 5, 6,
11, 12, 16,
17, 18, 19
1, 2, 3, 4, 5,
7, 8, 9, 10,
13, 14
8. Solve present value problems related
to deferred annuities and bonds.
15 7, 8, 13, 14 5, 6, 11, 12
*9. Apply expected cash flows to present
value measurement.
20, 21 13, 14
*10. Use a financial calculator to solve time
value of money problems.
22, 23, 24 15, 16, 17
6-3
ASSIGNMENT CHARACTERISTICS TABLE
Item Description
Level of
Difficulty
Time
(minutes)
E6-1 Using interest tables. Simple 510
E6-2 Simple and compound interest computations. Simple 510
E6-3 Computation of future values and present values. Simple 1015
E6-4 Computation of future values and present values. Moderate 1520
E6-5 Computation of present value. Simple 1015
E6-6 Future value and present value problems. Moderate 1520
E6-7 Computation of bond prices. Moderate 1217
E6-8 Computations for a retirement fund. Simple 1015
E6-9 Unknown rate. Moderate 510
E6-10 Unknown periods and unknown interest rate. Simple 1015
E6-11 Evaluation of purchase options. Moderate 1015
E6-12 Analysis of alternatives. Simple 1015
E6-13 Computation bond liability. Moderate 1520
E6-14 Computation of pension liability. Moderate 1520
E6-15 Investment decision. Moderate 1520
E6-16 Retirement of debt. Simple 1015
E6-17 Computation of amount of rentals. Simple 1015
E6-18 Least costly payoffordinary annuity. Simple 1015
E6-19 Least costly payoffannuity due. Simple 1015
E6-20 Expected cash flows. Simple 510
E6-21 Expected cash flows and present value. Moderate 1520
*E6-22 Determine the interest rate (with a calculator). Simple 35
*E6-23 Determine the interest rate (with a calculator). Simple 35
*E6-24 Determine the interest rate (with a calculator). Simple 35
P6-1 Various time value situations. Moderate 1520
P6-2 Various time value situations. Moderate 1520
P6-3 Analysis of alternatives. Moderate 2030
P6-4 Evaluating payment alternatives. Moderate 2030
P6-5 Analysis of alternatives. Moderate 2025
P6-6 Purchase price of a business (deferred annuities). Moderate 2530
P6-7 Time value concepts applied to solve business problems. Complex 3035
P6-8 Analysis of alternatives. Moderate 2030
P6-9 Analysis of business problems. Complex 3035
P6-10 Analysis of lease versus purchase. Complex 3035
P6-11 Pension funding, deferred annuity. Complex 2530
P6-12 Pension fundingethics Moderate 2025
P6-13 Expected cash flows and present value. Moderate 2025
P6-14 Expected cash flows and present value. Moderate 2025
*P6-15 Various time value of money situations. Moderate 1015
*P6-16 Various time value of money situations. Moderate 1015
*P6-17 Various time value of money situations. Moderate 1015
6-4
ANSWERS TO QUESTIONS
1. Money has value because with it one can acquire assets and services and discharge obligations.
The holding, borrowing or lending of money can result in costs or earnings. And the longer the
time period involved, the greater the costs or the earnings. The cost or earning of money as a
function of time is the time value of money.
Accountants must have a working knowledge of compound interest, annuities, and present value
concepts because of their application to numerous types of business events and transactions
which require proper valuation and presentation. These concepts are applied in the following
areas: (1) sinking funds, (2) installment contracts, (3) pensions, (4) long-term assets, (5) leases,
(6) notes receivable and payable, (7) business combinations, and (8) amortization of premiums
and discounts.
2. Some situations in which present value measures are used in accounting include:
(a) Notes receivable and payablethese involve single sums (the face amounts) and may involve
annuities, if there are periodic interest payments.
(b) Leasesinvolve measurement of assets and obligations, which are based on the present
value of annuities (lease payments) and single sums (if there are residual values to be paid at
the conclusion of the lease).
(c) Pensions and other deferred compensation arrangementsinvolve discounted future annuity
payments that are estimated to be paid to employees upon retirement.
(d) Bond pricingthe price of bonds payable is comprised of the present value of the principal or
face value of the bond plus the present value of the annuity of interest payments.
(e) Long-term assetsevaluating various long-term investments or assessing whether an asset is
impaired requires determining the present value of the estimated cash flows (may be single
sums and/or an annuity).
3. Interest is the payment for the use of money. It may represent a cost or earnings depending upon
whether the money is being borrowed or loaned. The earning or incurring of interest is a function
of the time, the amount of money, and the risk involved (reflected in the interest rate).
Simple interest is computed on the amount of the principal only, while compound interest is
computed on the amount of the principal plus any accumulated interest. Compound interest
involves interest on interest while simple interest does not.
4. The interest rate generally has three components:
(1) Pure rate of interestThis would be the amount a lender would charge if there were no
possibilities of default and no expectation of inflation.
(2) Expected inflation rate of interestLenders recognize that in an inflationary economy, they are
being paid back with less valuable dollars. As a result, they increase their interest rate to
compensate for this loss in purchasing power. When inflationary expectations are high, interest
rates are high.
(3) Credit risk rate of interestThe government has little or no credit risk (i.e., risk of nonpayment)
when it issues bonds. A business enterprise, however, depending upon its financial stability,
profitability, etc. can have a low or a high credit risk.
Accountants must have knowledge about these components because these components are
essential in identifying an appropriate interest rate for a given company or investor at any given
moment.
5. (a) Present value of an ordinary annuity at 8% for 10 periods (Table 6-4).
(b) Future value of 1 at 8% for 10 periods (Table 6-1).
(c) Present value of 1 at 8% for 10 periods (Table 6-2).
(d) Future value of an ordinary annuity at 8% for 10 periods (Table 6-3).
6-5
Questions Chapter 6 (Continued)
6. He should choose quarterly compounding, because the balance in the account on which interest
will be earned will be increased more frequently, thereby resulting in more interest earned on the
investment. As shown in the following calculation:
Semiannual compounding, assuming the amount is invested for 2 years:
n = 4
$1,000 X 1.16986 = $1,169.86
i = 4
Quarterly compounding, assuming the amount is invested for 2 years:
n = 8
$1,000 X 1.17166 = $1,171.66
i = 2
Thus, with quarterly compounding, Bill could earn $1.80 more.
7. $24,208.02 = $18,000 X 1.34489 (future value of 1 at 2
1
/
2
for 12 periods).
8. $27,919.50 = $50,000 X .55839 (present value of 1 at 6% for 10 periods).
9. An annuity involves (1) periodic payments or receipts, called rents, (2) of the same amount,
(3) spread over equal intervals, (4) with interest compounded once each interval.
Rents occur at the end of the intervals for ordinary annuities while the rents occur at the beginning
of the intervals for annuities due.
$30,000
10. Amount paid each year =
3.03735
(present value of an ordinary annuity at 12% for 4 years).
Amount paid each year = $9,877.03.
$160,000
11. Amount deposited each year =
4.64100
(future value of an ordinary annuity at 10% for 4 years).
Amount deposited each year = $34,475.33.
$160,000
12. Amount deposited each year =
5.10510
[future value of an annuity due at 10% for 4 years
(4.64100 X 1.10)].
Amount deposited each year = $31,341.21.
13. The process for computing the future value of an annuity due using the future value of an ordinary
annuity interest table is to multiply the corresponding future value of the ordinary annuity by one
plus the interest rate. For example, the factor for the future value of an annuity due for 4 years at
12% is equal to the factor for the future value of an ordinary annuity times 1.12.
14. The basis for converting the present value of an ordinary annuity table to the present value of an
annuity due table involves multiplying the present value of an ordinary annuity factor by one plus
the interest rate.
6-6
Questions Chapter 6 (Continued)
15. Present value = present value of an ordinary annuity of $25,000 for 20 periods at ? percent.
$210,000 = present value of an ordinary annuity of $25,000 for 20 periods at ? percent.
$210,000
Present value of an ordinary annuity for 20 periods at ? percent =
$25,000
= 8.4.
The factor 8.4 is closest to 8.51356 in the 10% column (Table 6-4).
16. 4.96764 Present value of ordinary annuity at 12% for eight periods.
2.40183 Present value of ordinary annuity at 12% for three periods.
2.56581 Present value of ordinary annuity at 12% for eight periods, deferred three periods.
The present value of the five rents is computed as follows:
2.56581 X $10,000 = $25,658.10.
17. (a) Present value of an annuity due.
(b) Present value of 1.
(c) Future value of an annuity due.
(d) Future value of 1.
18. $27,000 = PV of an ordinary annuity of $6,900 for five periods at ? percent.
$27,000
$6,900
= PV of an ordinary annuity for five periods at ? percent.
3.91304 = PV of an ordinary annuity for five periods at ?.
3.91304 = approximately 9%.
19. The IRS argues that the future reserves should be discounted to present value. The result would
be smaller reserves and therefore less of a charge to income. As a result, income would be higher
and income taxes may therefore be higher as well.
6-7
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 6-1
8% annual interest
i = 8%
PV = $10,000 FV = ?
0 1 2 3
n = 3
FV = $10,000 (FVF
3, 8%
)
FV = $10,000 (1.25971)
FV = $12,597.10
8% annual interest, compounded semiannually
i = 4%
PV = $10,000 FV = ?
0 1 2 3 4 5 6
n = 6
FV = $10,000 (FVF
6, 4%
)
FV = $10,000 (1.26532)
FV = $12,653.20
6-8
BRIEF EXERCISE 6-2
12% annual interest
i = 12%
PV = ? FV = $20,000
0 1 2 3 4
n = 4
PV = $20,000 (PVF
4, 12%
)
PV = $20,000 (.63552)
PV = $12,710.40
12% annual interest, compounded quarterly
i = 3%
PV = ? FV = $20,000
0 1 2 6 7 8
n = 16
PV = $20,000 (PVF
16, 3%
)
PV = $20,000 (.62317)
PV = $12,463.40
6-9
BRIEF EXERCISE 6-3
i = ?
PV = $30,000 FV = $222,000
0 1 2 19 20 21
n = 21
FV = PV (FVF
21, i
) PV = FV (PVF
21, i
)
OR
$222,000 = $30,000 (FVF
21, i
) $30,000 = $222,000 (PVF
21, i
)
FVF
21, i
= 7.40000 PVF
21, i
= .13514
i = 10% i = 10%
BRIEF EXERCISE 6-4
i = 5%
PV = $10,000 FV = $13,400
0 ?
n = ?
FV = PV (FVF
n, 5%
) PV = FV (PVF
n, 5%
)
OR
$13,400 = $10,000 (FVF
n, 5%
) $10,000 = $13,400 (PVF
n, 5%
)
FVF
n, 5%
= 1.34000 PVF
n, 5%
= .74627
n = 6 years n = 6 years
6-10
BRIEF EXERCISE 6-5
First payment today
i = 12%
R = FVAD =
$5,000 $5,000 $5,000 $5,000 $5,000

?
0 1 2 18 19 20
n = 20
FVAD = $5,000 (FVFOA
20, 12%
) 1.12
FVAD = $5,000 (72.05244) 1.12
FVAD = $403,494
First payment at year-end
i = 12%
FVOA =
?
$5,000 $5,000 $5,000 $5,000 $5,000
0 1 2 18 19 20
n = 20
FVOA = $5,000 (FVFOA
20, 12%
)
FVOA = $5,000 (72.05244)
FVOA = $360,262
6-11
BRIEF EXERCISE 6-6
i = 11%
FVOA =
R = ? ? ? ? $200,000
0 1 2 8 9 10
n = 10
$200,000 = R (FVFOA
10, 11%
)
$200,000 = R (16.72201)
$200,000
16.72201
= R
R = $11,960
BRIEF EXERCISE 6-7
12% annual interest
i = 12%
PV = ? FV = $350,000
0 1 2 3 4 5
n = 5
PV = $350,000 (PVF
5, 12%
)
PV = $350,000 (.56743)
PV = $198,600.50
6-12
BRIEF EXERCISE 6-8
With quarterly compounding, there will be 20 quarterly compounding
periods, at 1/4 the interest rate:
PV = $350,000 (PVF
20, 3%
)
PV = $350,000 (.55368)
PV = $193,788
BRIEF EXERCISE 6-9
i = 10%
FVOA =
R = $100,000
$12,961 $12,961 $12,961
0 1 2 n
n = ?
$100,000 = $12,961 (FVFOA
n, 10%
)
$100,000
FVFOA
n, 10%
=
12,961
= 7.71545
Therefore, n = 6 years
6-13
BRIEF EXERCISE 6-10
First withdrawal at year-end
i = 8%
PVOA = R =
? $20,000 $20,000 $20,000 $20,000 $20,000
0 1 2 8 9 10
n = 10
PVOA = $20,000 (PVFOA
10, 8%
)
PVOA = $20,000 (6.71008)
PVOA = $134,202
First withdrawal immediately
i = 8%
PVAD =
?
R =
$20,000 $20,000 $20,000 $20,000 $20,000
0 1 2 8 9 10
n = 10
PVAD = $20,000 (PVFAD
10, 8%
)
PVAD = $20,000 (7.24689)
PVAD = $144,938
6-14
BRIEF EXERCISE 6-11
i = ?
PV = R =
$1,124.40 $75 $75 $75 $75 $75
0 1 2 16 17 18
n = 18
$1,124.40 = $75 (PVFOA
18, i
)
$1,124.40
PVF
18, i
=
75
= 14.992
Therefore, i = 2% per month
BRIEF EXERCISE 6-12
i = 8%
PV =
$200,000 R = ? ? ? ? ?
0 1 2 18 19 20
n = 20
$200,000 = R (PVFOA
20, 8%
)
$200,000 = R (9.81815)
R = $20,370
6-15
BRIEF EXERCISE 6-13
i = 12%
R =
$20,000 $20,000 $20,000 $20,000 $20,000
12/31/06 12/31/07 12/31/08 12/31/12 12/31/13 12/31/14
n = 8
FVOA = $20,000 (FVFOA
8, 12%
)
FVOA = $20,000 (12.29969)
FVOA = $245,994
BRIEF EXERCISE 6-14
i = 8%
PVOA = R =
? $20,000 $20,000 $20,000 $20,000
0 1 2 3 4 5 6 11 12
n = 4 n = 8
PVOA = $20,000 (PVFOA
111 1222 2 444 4,,, , 888 8%%% %
) PVOA = $20,000 (PVFOA
888 8,,, , 888 8%%% %
)(PVF
444 4,,, , 888 8%%% %
)
OR
PVOA = $20,000 (7.53608 3.31213) PVOA = $20,000 (5.74664)(.73503)
PVOA = $84,479 PVOA = $84,479
6-16
BRIEF EXERCISE 6-15
i = 8%
PV = ?
PVOA = R = $1,000,000
? $70,000 $70,000 $70,000 $70,000 $70,000
0 1 2 8 9 10
n = 10
$1,000,000 (PVF
10, 8%
) = $1,000,000 (.46319) = $463,190
70,000 (PVFOA
10, 8%
) = $70,000 (6.71008) 469,706
$932,896
BRIEF EXERCISE 6-16
PVOA = $20,000
$4,864.51 $4,864.51 $4,864.51 $4,864.51
0 1 2 5 6
$20,000 = $4,864.51 (PVOA
6, i%
)
(PVOA
6, i%
) = $20,000 $4,864.51
(PVOA
6, i%
) = 4.11141
Therefore, i% = 12
6-17
BRIEF EXERCISE 6-17
PVAD = $20,000
$? $? $? $?
0 1 2 5

6
$20,000 = Payment (PVAD
6, 12%
)
$20,000 (PVAD
6, 12%
) = Payment
$20,000 4.60478 = $4,343.31
6-18
SOLUTIONS TO EXERCISES
EXERCISE 6-1 (510 minutes)
(a) (b)
Rate of Interest Number of Periods
1. a. 9% 9
b. 3% 20
c. 5% 30
2. a. 9% 25
b. 5% 30
c. 3% 28
EXERCISE 6-2 (510 minutes)
(a) Simple interest of $1,600 per year X 8 $12,800
Principal 20,000
Total withdrawn $32,800
(b) Interest compounded annuallyFuture value of
1 @ 8% for 8 periods 1.85093
X $20,000
Total withdrawn $37,018.60
(c) Interest compounded semiannuallyFuture
value of 1 @ 4% for 16 periods 1.87298
X $20,000
Total withdrawn $37,459.60
EXERCISE 6-3 (1015 minutes)
(a) $7,000 X 1.46933 = $10,285.31.
(b) $7,000 X .43393 = $3,037.51.
(c) $7,000 X 31.77248 = $222,407.36.
(d) $7,000 X 12.46221 = $87,235.47.
6-19
EXERCISE 6-4 (1520 minutes)
(a) Future value of an ordinary
annuity of $4,000 a period
for 20 periods at 8% $183,047.84 ($4,000 X 45.76196)
Factor (1 + .08) X 1.08
Future value of an annuity
due of $4,000 a period at 8%
$197,691.67
(b) Present value of an ordinary
annuity of $2,500 for 30
periods at 10% $23,567.28 ($2,500 X 9.42691)
Factor (1 + .10) X 1.10
Present value of annuity
due of $2,500 for 30 periods
at 10% $25,924.00 (Or see Table 6-5 which
gives $25,924.03)
(c) Future value of an ordinary
annuity of $2,000 a period
for 15 periods at 10% $63,544.96 ($2,000 X 31.77248)
Factor (1 + 10) X 1.10
Future value of an annuity
due of $2,000 a period
for 15 periods at 10%
$69,899.46
(d) Present value of an ordinary
annuity of $1,000 for 6
periods at 9% $4,485.92 ($1,000 X 4.48592)
Factor (1 + .09) X 1.09
Present value of an annuity
date of $1,000 for 6 periods
at 9% $4,889.65 (Or see Table 6-5)
EXERCISE 6-5 (1015 minutes)
(a) $30,000 X 4.96764 = $149,029.20.
(b) $30,000 X 8.31256 = $249,376.80.
(c) ($30,000 X 3.03735 X .50663 = $46,164.38.
or (5.65022 4.11141) X $30,000 = $46,164.30 (difference of $.08 due to
rounding).
6-20
EXERCISE 6-6 (1520 minutes)
(a) Future value of $12,000 @ 10% for 10 years
($12,000 X 2.59374) = $31,124.88
(b) Future value of an ordinary annuity of $600,000
at 10% for 15 years ($600,000 X 31.77248) $19,063,488.00
Deficiency ($20,000,000 $19,063,488) $936,512.00
(c) $70,000 discounted at 8% for 10 years:
$70,000 X .46319 = $32,423.30
Accept the bonus of $40,000 now.
(Also, consider whether the 8% is an appropriate discount rate
since the president can probably earn compound interest at a
higher rate without too much additional risk.)
EXERCISE 6-7 (1217 minutes)
(a) $50,000 X .31524 = $15,762.00
+ $5,000 X 8.55948 = 42,797.40
$58,559.40
(b) $50,000 X .23939 = $11,969.50
+ $5,000 X 7.60608 = 38,030.40
$49,999.90
The answer should be $50,000; the above computation is off by 10
due to rounding.
(c) $50,000 X .18270 = $ 9,135.00
+ $5,000 X 6.81086 = 34,054,30
$43,189.30
6-21
EXERCISE 6-8 (1015 minutes)
(a) Present value of an ordinary annuity of 1
for 4 periods @ 8% 3.31213
Annual withdrawal X $20,000
Required fund balance on June 30, 2013 $66,242.60
(b) Fund balance at June 30, 2013 $66,242.60
Future value of an ordinary annuity at 8% 4.50611
= $14,700.62
for 4 years
Amount of each of four contributions is $14,700.62
EXERCISE 6-9 (10 minutes)
The rate of interest is determined by dividing the future value by the
present value and then finding the factor in the FVF table with n = 2 that
approximates that number:
$123,210 = $100,000 (FVF
2, i%
)
$123,210 $100,000 = (FVF
2, i%
)
1.2321 = (FVF
2, i%
)reading across the n = 2 row reveals that i = 11%.
EXERCISE 6-10 (1015 minutes)
(a) The number of interest periods is calculated by first dividing the
future value of $1,000,000 by $92,296, which is 10.83471the value
$1.00 would accumulate to at 10% for the unknown number of interest
periods. The factor 10.83471 or its approximate is then located in the
Future Value of 1 Table by reading down the 10% column to the
25-period line; thus, 25 is the unknown number of years Mike must
wait to become a millionaire.
(b) The unknown interest rate is calculated by first dividing the future
value of $1,000,000 by the present investment of $182,696, which is
5.47357the amount $1.00 would accumulate to in 15 years at an
unknown interest rate. The factor or its approximate is then located in
the Future Value of 1 Table by reading across the 15-period line to the
12% column; thus, 12% is the interest rate Venus must earn on her
investment to become a millionaire.
6-22
EXERCISE 6-11 (1015 minutes)
(a) Total interest = Total paymentsAmount owed today
$162,745.30 (10 X $16,274.53) $100,000 = $62,745.30.
(b) Sosa should borrow from the bank, since the 9% rate is lower than the
manufacturers 10% rate determined below.
PVOA
10, i%
= $100,000 $16,274.53
= 6.14457Inspection of the 10 period row reveals a rate
of 10%.
EXERCISE 6-12 (1015 minutes)
Building APV = $600,000.
Building B
Rent X (PV of annuity due of 25 periods at 12%) = PV
$69,000 X 8.78432 = PV
$606,118.08 = PV
Building C
Rent X (PV of ordinary annuity of 25 periods at 12%) = PV
$7,000 X 7.84314 = PV
$54,901.98 = PV
Cash purchase price $650,000.00
PV of rental income 54,901.98
Net present value $595,098.02
Answer: Lease Building C since the present value of its net cost is the
smallest.
6-23
EXERCISE 6-13 (1520 minutes)
Time diagram:
Lance Armstrong, Inc.
PV = ? i = 5%
PVOA = ? Principal
$2,000,000
interest
$110,000 $110,000 $110,000 $110,000 $110,000 $110,000
0 1 2 3 28 29 30
n = 30
Formula for the interest payments:
PVOA = R (PVFOA
n, i
)
PVOA = $110,000 (PVFOA
30, 5%
)
PVOA = $110,000 (15.37245)
PVOA = $1,690,970
Formula for the principal:
PV = FV (PVF
n, i
)
PV = $2,000,000 (PVF
30, 5%
)
PV = $2,000,000 (0.23138)
PV = $462,760
The selling price of the bonds = $1,690,970 + $462,760 = $2,153,730.
6-24
EXERCISE 6-14 (1520 minutes)
Time diagram:
i = 8%
R =
PVOA = ? $700,000 $700,000 $700,000
0 1 2 15 16 24 25
n = 15 n = 10
Formula: PVOA = R (PVFOA
n, i
)
PVOA = $700,000 (PVFOA
2515, 8%
)
PVOA = $700,000 (10.67478 8.55948)
PVOA = $700,000 (2.11530)
PVOA = $1,480,710
OR
Time diagram:
i = 8%
R =
PVOA = ? $700,000 $700,000 $700,000
0 1 2 15 16 24 25
FV(PV
n, i
) (PVOA
n, i
)
6-25
EXERCISE 6-14 (Continued)
(i) Present value of the expected annual pension payments at the end of
the 10
th
year:
PVOA = R (PVFOA
n, i
)
PVOA = $700,000 (PVFOA
10, 8%
)
PVOA = $700,000 (6.71008)
PVOA = $4,697,056
(ii) Present value of the expected annual pension payments at the
beginning of the current year:
PV = FV (PVF
n, i
)
PV = $4,697,056 (PVF
15,8%
)
PV = $4,697,056 (0.31524)
PV = $1,480,700*
*$10 difference due to rounding.
The companys pension obligation (liability) is $1,480,700.
6-26
EXERCISE 6-15 (1520 minutes)
(a)
i = 8%
PV = $1,000,000 FV = $1,999,000
0 1 2 n = ?
FVF(
n, 8%
) = $1,999,000 $1,000,000
= 1.999
reading down the 8% column, 1.999 corresponds to 9 periods.
(b) By setting aside $300,000 now, Andrew can gradually build the fund
to an amount to establish the foundation.
PV = $300,000 FV = ?
0

1 2

8 9
FV = $300,000 (FVF
999 9,,, , 888 8%%% %
)
= $300,000 (1.999)
= $599,700Thus, the amount needed from the annuity:
$1,999,000 $599,700 = $1,399,300.
$? $? $? FV = $1,399,300
0 1 2 8 9
Payments = FV (FVOA
9, 8%
)
= $1,399,300 12.48756
= $112,055.52.
6-27
EXERCISE 6-16 (1015 minutes)
Amount to be repaid on March 1, 2015.
Time diagram:
i = 6% per six months
PV = $70,000 FV = ?
3/1/05 3/1/06 3/1/07 3/1/13 3/1/14 3/1/15
n = 20 six-month periods
Formula: FV = PV (FVF
n, i
)
FV = $70,000 (FVF
20, 6%
)
FV = $70,000 (3.20714)
FV = $224,500
Amount of annual contribution to retirement fund.
Time diagram:
i = 10%
R R R R R FVAD =
R = ? ? ? ? ? $224,500
3/1/10 3/1/11 3/1/12 3/1/13 3/1/14 3/1/15
6-28
EXERCISE 6-16 (Continued)
1. Future value of ordinary annuity of 1 for 5 periods
at 10% 6.10510
2. Factor (1 + .10) X 1.10000
3. Future value of an annuity due of 1 for 5 periods
at 10% 6.71561
4. Periodic rent ($224,500 6.71561) $33,430
EXERCISE 6-17 (1015 minutes)
Time diagram:
i = 11%
R R R
PVOA = $365,755 ? ? ?
0

1

24 25
n = 25
Formula: PVOA = R (PVOA
n, i
)
$365,755 = R (PVFOA
25, 11%
)
$365,755 = R (8.42174)
R = $365,755 8.42174
R = $43,429.86
6-29
EXERCISE 6-18 (1015 minutes)
Time diagram:
i = 8%
PVOA = ? $300,000 $300,000 $300,000 $300,000 $300,000
0 1 2 13 14 15
n = 15
Formula: PVOA = R (PVFOA
n, i
)
PVOA = $300,000 (PVFOA
15, 8%
)
PVOA = $300,000 (8.55948)
R = $2,567,844
The recommended method of payment would be the 15 annual payments of
$300,000, since the present value of those payments ($2,567,844) is less
than the alternative immediate cash payment of $2,600,000.
6-30
EXERCISE 6-19 (1015 minutes)
Time diagram:
i = 8%
PVAD = ?
R =
$300,000 $300,000 $300,000 $300,000 $300,000
0 1 2 13 14 15
n = 15
Formula:
Using Table 6-4 Using Table 6-5
PVAD = R (PVFOA
n, i
) PVAD = R (PVFAD
n, i
)
PVAD = $300,000 (8.55948 X 1.08) PVAD = $300,000 (PVFAD
15, 8%
)
PVAD = $300,000 (9.24424) PVAD = $300,000 (9.24424)
PVAD = $2,773,272 PVAD = $2,773,272
The recommended method of payment would be the immediate cash
payment of $2,600,000, since that amount is less than the present value of
the 15 annual payments of $300,000 ($2,773,272).
6-31
EXERCISE 6-20 (510 minutes)
Expected
Cash Flow Probability Cash
Estimate X Assessment = Flow
(a) $ 3,800 20% $ 760
6,300 50% 3,150
7,500 30% 2,250
Total Expected
Value $ 6,160
(b) $ 5,400 30% $ 1,620
7,200 50% 3,600
8,400 20% 1,680
Total Expected
Value $ 6,900
(c) $(1,000) 10% $ 100
2,000 80% 1,600
5,000 10% 500
Total Expected
Value $ 2,000
EXERCISE 6-21 (1015 minutes)
Estimated
Cash Probability
Outflow X Assessment = Expected Cash Flow
$ 200 10% $ 20
450 30% 135
550 50% 275
750 10% 75 X PV
Factor,
n = 2, I = 6% Present Value
$ 505 X 0.89 $ 449.45
6-32
*EXERCISE 6-22
10 ? 19,000 0 49,000
N I/YR. PV PMT FV
9.94%
*EXERCISE 6-23
10 ? 42,000 6,500 0
N I/YR. PV PMT FV
8.85%
*EXERCISE 6-24
40 ? 178,000 14,000 0
N I/YR. PV PMT FV
7.49%
(semiannual)
6-33
TIME AND PURPOSE OF PROBLEMS
Problem 6-1 (Time 1520 minutes)
Purposeto present an opportunity for the student to determine how to use the present value tables in
various situations. Each of the situations presented emphasizes either a present value of 1 or a present
value of an ordinary annuity situation. Two of the situations will be more difficult for the student because
a noninterest-bearing note and bonds are involved.
Problem 6-2 (Time 1520 minutes)
Purposeto present an opportunity for the student to determine solutions to four present and future
value situations. The student is required to determine the number of years over which certain amounts
will accumulate, the rate of interest required to accumulate a given amount, and the unknown amount
of periodic payments. The problem develops the students ability to set up present and future value
equations and solve for unknown quantities.
Problem 6-3 (Time 2030 minutes)
Purposeto present the student with an opportunity to determine the present value of the costs of
competing contracts. The student is required to decide which contract to accept.
Problem 6-4 (Time 2030 minutes)
Purposeto present the student with an opportunity to determine the present value of two lottery
payout alternatives. The student is required to decide which payout option to choose.
Problem 6-5 (Time 2025 minutes)
Purposeto provide the student with an opportunity to determine which of four insurance options
results in the largest present value. The student is required to determine the present value of options
which include the immediate receipt of cash, an ordinary annuity, an annuity due, and an annuity of
changing amount. The student must also deal with interest compounded quarterly. This problem is a
good summary of the application of present value techniques.
Problem 6-6 (Time 2530 minutes)
Purposeto present an opportunity for the student to determine the present value of a series of
deferred annuities. The student must deal with both cash inflows and outflows to arrive at a present
value of net cash inflows. A good problem to develop the students ability to manipulate the present
value table factors to efficiently solve the problem.
Problem 6-7 (Time 3035 minutes)
Purposeto present the student an opportunity to use time value concepts in business situations.
Some of the situations are fairly complex and will require the student to think a great deal before
answering the question. For example, in one situation a student must discount a note and in another
must find the proper interest rate to use in a purchase transaction.
Problem 6-8 (Time 2030 minutes)
Purposeto present the student with an opportunity to determine the present value of an ordinary
annuity and annuity due for three different cash payment situations. The student must then decide
which cash payment plan should be undertaken.
6-34
Time and Purpose of Problems (Continued)
Problem 6-9 (Time 3035 minutes)
Purposeto present the student with the opportunity to work three different problems related to time
value concepts: purchase versus lease, determination of fair value of a note, and appropriateness of
taking a cash discount.
Problem 6-10 (Time 3035 minutes)
Purposeto present the student with the opportunity to assess whether a company should purchase or
lease. The computations for this problem are relatively complicated.
Problem 6-11 (Time 2530 minutes)
Purposeto present the student an opportunity to apply present value to retirement funding problems,
including deferred annuities.
Problem 6-12 (Time 2025 minutes)
Purposeto provide the student an opportunity to explore the ethical issues inherent in applying time
value of money concepts to retirement plan decisions.
Problem 6-13 (Time 2025 minutes)
Purposeto present the student an opportunity to compute expected cash flows and then apply
present value techniques to determine a warranty liability.
Problem 6-14 (Time 2025 minutes)
Purposeto present the student an opportunity to compute expected cash flows and then apply
present value techniques to determine the fair value of an asset.
*Problems 6-15, 6-16, 6-17 (Time 1015 minutes each)
Purposeto present the student an opportunity to use a financial calculator to solve time value of
money problems.
6-35
SOLUTIONS TO PROBLEMS
PROBLEM 6-1
(a) Given no established value for the building, the fair market value of
the note would be estimated to value the building.
Time diagram:
i = 9%
PV = ? FV = $275,000
1/1/07 1/1/08 1/1/09 1/1/10
n = 3
Formula: PV = FV (PVF
n, i
)
PV = $275,000 (PVF
3, 9%
)
PV = $275,000 (.77218)
PV = $212,349.50
Cash equivalent price of building
$212,349.50
Less: Book value ($250,000 $100,000)
150,000.00
Gain on disposal of the building
$ 62,349.50
6-36
PROBLEM 6-1 (Continued)
(b) Time diagram:
i = 11%
Principal
$200,000
Interest
PVOA = ? $18,000 $18,000 $18,000 $18,000
1/1/07 1/1/08 1/1/09 1/1/2016 1/1/2017
n = 10
Present value of the principal
FV (PVF
10, 11%
) = $200,000 (.35218) = $ 70,436.00
Present value of the interest payments
R (PVFOA
10, 11%
) = $18,000 (5.88923) = 106,006.14
Combined present value (purchase price) $176,442.14
(c) Time diagram:
i = 8%
PVOA = ? $4,000 $4,000 $4,000 $4,000 $4,000
0 1 2 8 9 10
n = 10
Formula: PVOA = R (PVFOA
n,i
)
PVOA = $4,000 (PVFOA
10, 8%
)
PVOA = $4,000 (6.71008)
PVOA = $26,840.32 (cost of machine)
6-37
PROBLEM 6-1 (Continued)
(d) Time diagram:
i = 12%
PVOA = ?
$20,000 $5,000 $5,000 $5,000 $5,000 $5,000 $5,000 $5,000 $5,000
0 1 2 3 4 5 6 7 8
n = 8
Formula: PVOA = R (PVFOA
n,i
)
PVOA = $5,000 (PVFOA
8, 12%
)
PVOA = $5,000 (4.96764)
PVOA = $24,838.20
Cost of tractor = $20,000 + $24,838.20 = $44,838.20
(e) Time diagram:
i = 11%
PVOA = ? $100,000 $100,000 $100,000 $100,000
0 1 2 8 9
n = 9
Formula: PVOA = R (PVFOA
n, i
)
PVOA = $100,000 (PVFOA
9, 11%
)
PVOA = $100,000 (5.53705)
PVOA = $553,705
6-38
PROBLEM 6-2
(a) Time diagram:
i = 8% FV OA = $70,000
R R R R R R R R
R = ? ? ? ? ? ? ? ?
0 1 2 3 4 5 6 7 8
n = 8
Formula: FVOA = R (FVFOA
n,i
)
$70,000 = R (FVFOA
8, 8%
)
$70,000 = R (10.63663)
R = $70,000 10.63663
R = $6,581.03
(b) Time diagram:
i = 12%
FVAD =
R R R R 500,000
R = ? ? ? ?
40 41 42 64 65
n = 25
6-39
PROBLEM 6-2 (Continued)
1. Future value of an ordinary annuity of 1 for
25 periods at 12% 133.33387
2. Factor (1 + .12) 1.1200
3. Future value of an annuity due of 1 for 25
periods at 12% 149.33393
4. Periodic rent ($500,000 149.33393) $3,348.20
(c) Time diagram:
i = 9%
PV = $20,000 FV = $56,253
0

1 2 3

n
Future value approach Present value approach
FV = PV (FVF
n, i
) PV = FV (PVF
n, i
)
or
$56,253 = $20,000 (FVF
n, 9%
) $20,000 = $56,253 (PVF
n, 9%
)
= $56,253 $20,000 = $20,000 $56,253
FVF
n, 9%
= 2.81265
PVF
n, 9%
= .35554
2.81265 is approximately the
value of $1 invested at 9%
for 12 years.
.35554 is approximately the
present value of $1 discounted
at 9% for 12 years.
6-40
PROBLEM 6-2 (Continued)
(d) Time diagram:
i = ?
PV = FV =
$18,181 $27,600
0 1 2 3 4
n = 4
Future value approach Present value approach
FV = PV (FVF
n, i
) PV = FV (PVF
n, i
)
or
$27,600 = $18,181 (FVF
4, i
) $18,181 = $27,600 (PVF
4, i
)
= $27,600 $18,181 = $18,181 $27,600
FVF
4, i
= 1.51807
PVF
4, i
= .65873
1.51807 is the value of $1
invested at 11% for 4 years.
.65873 is the present value of $1
discounted at 11% for 4 years.
6-41
PROBLEM 6-3
Time diagram (Bid A):
i = 9%
$63,000
PVOA = R =
? 2,400 2,400 2,400 2,400 63,000 2,400 2,400 2,400 2,400 0
0 1 2 3 4 5 6 7 8 9 10
n = 9
Present value of initial cost
12,000 X $5.25 = $63,000 (incurred today) $ 63,000.00
Present value of maintenance cost (years 14)
12,000 X $.20 = $2,400
R (PVFOA
4, 9%
) = $2,400 (3.23972) 7,775.33
Present value of resurfacing
FV (PVF
5, 9%
) = $63,000 (.64993) 40,945.59
Present value of maintenance cost (years 69)
R (PVFOA
95, 9%
) = $2,400 (5.99525 3.88965) 5,053.44
Present value of outflows for Bid A $116,774.36
6-42
PROBLEM 6-3 (Continued)
Time diagram (Bid B):
i = 9%
$114,000
PVOA = R =
? 1,080 1,080 1,080 1,080 1,080 1,080 1,080 1,080 1,080 0
0 1 2 3 4 5 6 7 8 9 10
n = 9
Present value of initial cost
12,000 X $9.50 = $114,000 (incurred today) $114,000.00
Present value of maintenance cost
12,000 X $.09 = $1,080
R (PVOA
9, 9%
) = $1,080 (5.99525) 6,474.87
Present value of outflows for Bid B $120,474.87
Bid A should be accepted since its present value is the lower.
6-43
PROBLEM 6-4
Lump sum alternative: Present Value = $900,000 X (1 .46) = $486,000.
Annuity alternative: Payments = $62,000 X (1 .25) = $46,500.
Present Value = Payments (PVAD
20, 8%
)
= $46,500 (10.60360)
= $493,067.40.
OMalley should choose the annuity payout; its present value is $7,067.40
greater.
6-44
PROBLEM 6-5
(a) The present value of $55,000 cash paid today is $55,000.
(b) Time diagram:
i = 2
1
/
2
% per quarter
PVOA = R =
? $3,700 $3,700 $3,700 $3,700 $3,700
0 1 2 18 19 20
n = 20 quarters
Formula: PVOA = R (PVFOA
n, i
)
PVOA = $3,700 (PVFOA
20, 21/2%
)
PVOA = $3,700 (15.58916)
PVOA = $57,679.89
(c) Time diagram:
i = 2
1
/
2
% per quarter
$18,000
PVAD =
R = $1,600 $1,600 $1,600 $1,600 $1,600
0 1 2 38 39 40
n = 40 quarters
Formula: PVAD = R (PVFAD
n, i
)
PVAD = $1,600 (PVFAD
40, 21/2%
)
PVAD = $1,600 (25.73034)
PVAD = $41,168.54
The present value of option (c) is $18,000 + $41,168.54, or
$59,168.54.
6-45
PROBLEM 6-5 (Continued)
(d) Time diagram:
i = 2
1
/
2
% per quarter
PVOA = R =
? $1,200 $1,200 $1,200 $1,200
PVOA = R =
? $4,000 $4,000 $4,000
0

1 11 12 13 14

36 37
n = 12 quarters n = 25 quarters
Formulas:
PVOA = R (PVFOA
n,i
) PVOA = R (PVFOA
n,i
)
PVOA = $4,000 (PVFOA
12, 21/2%
) PVOA = $1,200 (PVFOA
3712, 21/2%
)
PVOA = $4,000 (10.25776) PVOA = $1,200 (23.95732 10.25776)
PVOA = $41,031.04 PVOA = $16,439.47
The present value of option (d) is $41,031.04 + $16,439.47, or
$57,470.51.
Present values:
(a) $55,000.
(b) $57,679.89.
(c) $59,168.54.
(d) $57,470.51.
Option (c) is the best option, based upon present values alone.
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PROBLEM 6-6
6-47
PROBLEM 6-7
(a) Time diagram (alternative one):
i = ?
PVOA =
$572,000 R =
$80,000 $80,000 $80,000 $80,000 $80,000
0 1

2 10

11 12
n = 12
Formulas: PVOA = R (PVFOA
n, i
)
$572,000 = $80,000 (PVFOA
12, i
)
PVFOA
12, i
= $572,000 $80,000
PVFOA
12, i
= 7.15
7.15 is present value of an annuity of $1 for 12 years discounted at
approximately 9%.
Time diagram (alternative two):
i = ?
PV = $572,000 FV = $1,900,000
n = 12
6-48
PROBLEM 6-7 (Continued)
Future value approach Present value approach
FV = PV (FVF
n, i
) PV = FV (PVF
n, i
)
or
$1,900,000 = $572,000 (FVF
12, i
) $572,000 = $1,900,000 (PVF
12, i
)
FVF
12, I
= $1,900,000 $572,000 PVF
12, i
= $572,000 $1,900,000
FVF
12, I
= 3.32168 PVF
12, i
= .30105
3.32168 is the future value of $1
invested at between 10% and
11% for 12 years.
.30105 is the present value of
$1 discounted at between 10%
and 11% for 12 years.
Lee should choose alternative two since it provides a higher rate
of return.
(b) Time diagram:
i = ?
($824,150 $200,000)
PVOA = R =
$624,150 $76,952 $76,952 $76,952 $76,952
0 1 8 9 10
n = 10 six-month periods
6-49
PROBLEM 6-7 (Continued)
Formulas: PVOA = R (PVFOA
n, i
)
$624,150 = $76,952 (PVFOA
10, i
)
PVOA
10, i
= $624,150 $76,952
PVOA
10, i
= 8.11090
8.11090 is the present value of a 10-period annuity of $1 discounted at
4%. The interest rate is 4% semiannually, or 8% annually.
(c) Time diagram:
i = 5% per six months
PV = ?
PVOA = R =
? $24,000 $24,000 $24,000 $24,000 $24,000 ($600,000 X 8% X 6/12)
0 1 2 8 9 10
n = 10 six-month periods [(7 2) X 2]
Formulas:
PVOA = R (PVFOA
n, i
) PV = FV (PVF
n, i
)
PVOA = $24,000 (PVFOA
10, 5%
) PV = $600,000 (PVF
10, 5%
)
PVOA = $24,000 (7.72173) PV = $600,000 (.61391)
PVOA = $185,321.52 PV = $368,346
Combined present value (amount received on sale of note):
$185,321.52 + $368,346 = $553,667.52
6-50
PROBLEM 6-7 (Continued)
(d) Time diagram (future value of $300,000 deposit)
i = 21/2% per quarter
PV =
$300,000 FV = ?
12/31/07 12/31/08 12/31/16 12/31/17
n = 40 quarters
Formula: FV = PV (FVF
n, i
)
FV = $300,000 (FVF
40, 2 1/2%
)
FV = $300,000 (2.68506)
FV = $805,518
Amount to which quarterly deposits must grow:
$1,300,000 $805,518 = $494,482.
Time diagram (future value of quarterly deposits)
i = 21/2% per quarter
R R R R R R R R R
R = ? ? ? ? ? ? ? ? ?
12/31/07 12/31/08 12/31/16 12/31/17
n = 40 quarters
6-51
PROBLEM 6-7 (Continued)
Formulas: FVOA = R (FVFOA
n, i
)
$494,482 = R (FVFOA
40, 2 1/2%
)
$494,482 = R (67.40255)
R = $494,482 67.40255
R = $7,336.25
6-52
PROBLEM 6-8
Vendor A: $15,000 payment
X 6.14457 (PV of ordinary annuity 10%, 10 periods)
$ 92,168.55
+ 45,000.00 down payment
+ 10,000.00 maintenance contract
$147,168.55 total cost from Vendor A
Vendor B: $8,000 semiannual payment
18.01704 (PV of annuity due 5%, 40 periods)
$144,136.32
Vendor C: $1,000
X 3.79079 (PV of ordinary annuity of 5 periods, 10%)
$ 3,790.79 PV of first 5 years of maintenance
$2,000 [PV of ordinary annuity 15 per., 10% (7.60608)
X 3.81529 PV of ordinary annuity 5 per., 10% (3.79079)]
$ 7,630.58 PV of next 10 years of maintenance
$3,000 [(PV of ordinary annuity 20 per., 10% (8.51356)
X .90748 PV of ordinary annuity 15 per., 10% (7.60608)]
$ 2,722.44 PV of last 5 years of maintenance
Total cost of press and maintenance Vendor C:
$125,000.00 cash purchase price
3,790.79 maintenance years 15
7,630.58 maintenance years 615
2,722.44 maintenance years 1620
$139,143.81
The press should be purchased from Vendor C, since the present value of
the cash outflows for this option is the lowest of the three options.
6-53
PROBLEM 6-9
(a) Time diagram for the first ten payments:
i = 10%
PVAD = ?
R =
$800,000 $800,000 $800,000 $800,000 $800,000 $800,000 $800,000 $800,000
0 1 2 3 7 8 9 10
n = 10
Formula for the first ten payments:
PVAD = R (PVFAD
n, i
)
PVAD = $800,000 (PVFAD
10, 10%
)
PVAD = $800,000 (6.75902)
PVOA = $5,407,216
Time diagram for the last ten payments:
i = 10%
R =
PVOA = ? $300,000 $300,000 $300,000 $300,000
0

1 2 10 11

18 19 20
n = 9 n = 10
6-54
PROBLEM 6-9 (Continued)
Formula for the last ten payments:
PVOA = R (PVFOA
n, i
)
PVOA = $300,000 (PVFOA
19 9, 10%
)
PVOA = $300,000 (8.36492 5.75902)
PVOA = $300,000 (2.6059)
PVOA = $781,770
Note: The present value of an ordinary annuity is used here, not the
present value of an annuity due.
The total cost for leasing the facilities is:
$5,407,216 + $781,770 = $6,188,986.
OR
Time diagram for the last ten payments:
i = 10%
PV = ? R = $300,000 $300,000 $300,000 $300,000
0

1 2

9 10 17 18 19
FVF (PVF
n, i
) R (PVFOA
n, i
)
6-55
PROBLEM 6-9 (Continued)
Formulas for the last ten payments:
(i) Present value of the last ten payments:
PVOA = R (PVFOA
n, i
)
PVOA = $300,000 (PVFOA
10, 10%
)
PVOA = $300,000 (6.14457)
PVOA = $1,843,371
(ii) Present value of the last ten payments at the beginning of current
year:
PV = FV (PVF
n, i
)
PV = $1,843,371 (PVF
9, 10%
)
PV = $1,843,371 (.42410)
PV = $781,774*
*$4 difference due to rounding.
Cost for leasing the facilities $5,407,216 + $781,774 = $6,188,990
Since the present value of the cost for leasing the facilities,
$6,188,990, is less than the cost for purchasing the facilities,
$7,200,000, Starship Enterprises should lease the facilities.
6-56
PROBLEM 6-9 (Continued)
(b) Time diagram:
i = 11%
PVOA = ?
R =
$12,000 $12,000 $12,000 $12,000 $12,000 $12,000 $12,000
0 1 2 3

6 7 8 9
n = 9
Formula: PVOA = R (PVFOA
n, i
)
PVOA = $12,000 (PVFOA
9, 11%
)
PVOA = $12,000 (5.53705)
PVOA = $66,444.60
The fair value of the note is $66,444.60.
(c) Time diagram:
Amount paid =
$784,000
0 10 30
Amount paid =
$800,000
6-57
PROBLEM 6-9 (Continued)
Cash discount = $800,000 (2%) = $16,000
Net payment = $800,000 $16,000 = $784,000
If the company decides not to take the cash discount, then the
company can use the $784,000 for an additional 20 days. The implied
interest rate for postponing the payment can be calculated as follows:
(i) Implied interest for the period from the end of discount period to
the due date:
Cash discount lost if not paid within the discount period
Net payment being postponed
= $16,000/$784,000
= 0.0204
(ii) Convert the implied interest rate to annual basis:
Daily interest = 0.0204/20 = 0.00102
Annual interest = 0.00102 X 365 = 37.23%
Since Starships cost of funds, 10%, is less than the implied
interest rate for cash discount, 37.23%, it should continue the
policy of taking the cash discount.
6-58
PROBLEM 6-10
1. Purchase.
Time diagrams:
Installments
i = 10%
PVOA = ?
R =
$300,000 $300,000 $300,000 $300,000 $300,000
0 1 2 3 4 5
n = 5
Property taxes and other costs
i = 10%
PVOA = ?
R =
$56,000 $56,000 $56,000 $56,000 $56,000 $56,000
0 1 2 9 10 11 12
n = 12
6-59
PROBLEM 6-10 (Continued)
Insurance
i = 10%
PVAD = ?
R =
$27,000 $27,000 $27,000 $27,000 $27,000 $27,000
0 1 2 9 10 11 12
n = 12
Salvage Value
PV = ? FV = $500,000
0 1 2 9 10 11 12
n = 12
Formula for installments:
PVOA = R (PVFOA
n, i
)
PVOA = $300,000 (PVFOA
5, 10%
)
PVOA = $300,000 (3.79079)
PVOA = $1,137,237
6-60
PROBLEM 6-10 (Continued)
Formula for property taxes and other costs:
PVOA = R (PVFOA
n, i
)
PVOA = $56,000 (PVFOA
12, 10%
)
PVOA = $56,000 (6.81369)
PVOA = $381,567
Formula for insurance:
PVAD = R (PVFAD
n, i
)
PVAD = $27,000 (PVFAD
12, 10%
)
PVAD = $27,000 (7.49506)
PVAD = $202,367
Formula for salvage value:
PV = FV (PVF
n, i
)
PV = $500,000 (PVF
12, 10%
)
PV = $500,000 (0.31863)
PV = $159,315
6-61
PROBLEM 6-10 (Continued)
Present value of net purchase costs:
Down payment $ 400,000
Installments 1,137,237
Property taxes and other costs 381,567
Insurance 202,367
Total costs $2,121,171
Less: Salvage value 159,315
Net costs $1,961,856
2. Lease.
Time diagrams:
Lease payments
i = 10%
PVAD = ?
R =
$240,000 $240,000 $240,000 $240,000 $240,000
0

1 2 10 11 12
n = 12
Interest lost on the deposit
i = 10%
PVOA = ?
R =
$10,000 $10,000 $10,000 $10,000 $10,000
0 1 2 10 11 12
n = 12
6-62
PROBLEM 6-10 (Continued)
Formula for lease payments:
PVAD = R (PVFAD
n, i
)
PVAD = $240,000 (PVFAD
12, 10%
)
PVAD = $240,000 (7.49506)
PVAD = $1,798,814
Formula for interest lost on the deposit:
Interest lost on the deposit per year = $100,000 (10%) = $10,000
PVOA = R (PVFOA
n, i
)
PVOA = $10,000 (PVFOA
12, 10%
)
PVOA = $10,000 (6.81369)
PVOA = $68,137*
Cost for leasing the facilities = $1,798,814 + $68,137 = $1,866,951
Rijo Inc. should lease the facilities because the present value of the
costs for leasing the facilities, $1,866,951, is less than the present
value of the costs for purchasing the facilities, $1,961,856.
*OR: $100,000 ($100,000 X .31863) = $68,137
6-63
PROBLEM 6-11
(a) Annual retirement benefits.
Maugaritecurrent salary $ 40,000.00
X 2.56330 (future value of 1, 24 periods, 4%)
102,532.00 annual salary during last year of
work
X .50 retirement benefit %
$ 51,266.00 annual retirement benefit
Kennycurrent salary $30,000.00
X 3.11865 (future value of 1, 29 periods, 4%)
93,559.50 annual salary during last year of
work
X .40 retirement benefit %
$37,424.00 annual retirement benefit
Anitacurrent salary $15,000.00
X 2.10685 (future value of 1, 19 periods, 4%)
31,602.75 annual salary during last year of
work
X .40 retirement benefit %
$12,641.00 annual retirement benefit
Williecurrent salary $15,000.00
X 1.73168 (future value of 1, 14 periods, 4%)
25,975.20 annual salary during last year of
work
X .40 retirement benefit %
$10,390.00 annual retirement benefit
6-64
PROBLEM 6-11 (Continued)
(b) Fund requirements after 15 years of deposits at 12%.
Maugarite will retire 10 years after deposits stop.
$ 51,266.00 annual plan benefit
[PV of an annuity due for 30 periods PV of an
X 2.69356 annuity due for 10 periods (9.02181 6.32825)]
$138,088.00
Kenny will retire 15 years after deposits stop.
$37,424.00 annual plan benefit
X 1.52839 [PV of an annuity due for 35 periods PV of an
annuity due for 15 periods (9.15656 7.62817)]
$57,198.00
Anita will retire 5 years after deposits stop.
$12,641.00 annual plan benefit
X 4.74697 [PV of an annuity due for 25 periods PV of an
annuity due for 5 periods (8.78432 4.03735)]
$60,006.00
Willie will retire the beginning of the year after deposits stop.
$10,390.00 annual plan benefit
X 8.36578 (PV of an annuity due for 20 periods)
$86,920.00
6-65
PROBLEM 6-11 (Continued)
$138,088.00 Maugarite
57,198.00 Kenny
60,006.00 Anita
86,920.00 Willie
$342,212.00 Required fund balance at the end of the 15 years of
deposits.
(c) Required annual beginning-of-the-year deposits at 12%:
Deposit X (future value of an annuity due for 15 periods at 12%) = FV
Deposit X (37.27972 X 1.12) = $342,212.00
Deposit = $342,212.00 41.75329
Deposit = $8,196.00.
6-66
PROBLEM 6-12
(a) The time value of money would suggest that NET Lifes discount rate
was substantially higher than First Securitys. The actuaries at NET
Life are making different assumptions about inflation, employee
turnover, life expectancy of the work force, future salary and wage
levels, return on pension fund assets, etc. NET Life may operate at
lower gross and net margins and it may provide fewer services.
(b) As the controller of KBS, Qualls assumes a fiduciary responsibility to
the present and future retirees of the corporation. As a result, he is
responsible for ensuring that the pension assets are adequately
funded and are adequately protected from most controllable risks. At
the same time, Qualls is responsible for the financial condition of
KBS. In other words, he is obligated to find ethical ways of increasing
the profits of KBS, even if it means switching pension funds to a less
costly plan. At times, Qualls role to retirees and his role to the
corporation can be in conflict, especially if Qualls is a member of a
professional group such as CPAs or CMAs.
(c) If KBS switched to NET Life
The primary beneficiaries of Qualls decision would be the
corporation and its many stockholders by virtue of reducing 8 million
dollars of annual pension costs.
The present and future retirees of KBS may be negatively affected by
Qualls decision because the chance of losing a future benefit may be
increased by virtue of higher risks (as reflected in the discount rate
and NET Lifes weaker reputation).
If KBS stayed with First Security
In the short run, the primary beneficiaries of Qualls decision would
be the employees and retirees of KBS given the lower risk pension
asset plan.
KBS and its many stakeholders could be negatively affected by
Qualls decision to stay with First Security because of the companys
inability to trim 8 million dollars from its operating expenses.
6-67
PROBLEM 6-13
Cash Flow Probability
Estimate X Assessment = Expected Cash Flow
2008 $ 2,000 20% $ 400
4,000 60% 2,400
5,000 20% 1,000 X PV
Factor,
n = 1, I = 5% Present Value
$ 3,800 0.95238 $ 3,619.04
2009 $ 2,500 30% $ 750
5,000 50% 2,500
6,000 20% 1,200 X PV
Factor,
n = 2, I = 5% Present Value
$ 4,450 0.90703 $ 4,036.28
2010 $ 3,000 30% $ 900
6,000 40% 2,400
7,000 30% 2,100 X PV
Factor,
n = 3, I = 5% Present Value
$ 5,400 0.86384 $ 4,664.74
Total Estimated Liability $ 12,320.06
6-68
PROBLEM 6-14
Cash Flow Probability
Estimate X Assessment = Expected Cash Flow
2008 $ 6,000 40% $ 2,400
8,000 60% 4,800 X PV
Factor,
n = 1, I = 6% Present Value
$ 7,200 0.9434 $ 6,792.48
2009 $ (500) 20% $ (100)
2,000 60% 1,200
3,000 20% 600 X PV
Factor,
n = 2, I = 6% Present Value
$ 1,700 0.89 $ 1,513.00
Scrap
Value
Received
at the End
of 2009 $ 500 50% $ 250
700 50% 350 X PV
Factor,
n = 2, I = 6% Present Value
$ 600 0.89 $ 534.00
Estimated Fair Value $ 8,839.48
6-69
*PROBLEM 6-15
(a)
Inputs: 8 7.25 0 ? 70,000
N I PV PMT FV
Answer: 6,761.57
(b)
Noteset to begin mode.
Inputs: 25 9.65 0 ? 500,000
N I PV PMT FV
Answer: 4,886.59
(c)
Inputs: 4 ? 17,000 0 26,000
N I PV PMT FV
Answer: 11.21
6-70
*PROBLEM 6-16
(a)
Inputs: 15 ? 150,000 20,000 0
N I PV PMT FV
Answer: 10.25
(b)
Inputs: 7 7.35 ? 16,000 0
N I PV PMT FV
Answer: 85,186.34
(c)
Inputs: 10 10.65 ? 16,000 200,000
N I PV PMT FV
Answer: 168,323.64
6-71
*PROBLEM 6-17
(a)
Inputs: 20 5.25 180,000 ? 0
N I PV PMT FV
Answer: 14.751.41
(b)
Noteset payments at 12 per year.
Inputs: 96 9.1 35,000 ? 0
N I PV PMT FV
Answer: 514.57
(c)
Noteset to begin mode.
Inputs: 5 8.25 8,000 ? 0
N I PV PMT FV
Answer: 1,863.16
(d)
Noteset back to end mode.
Inputs: 5 8.25 8,000 ? 0
N I PV PMT FV
Answer: 2,016.87
6-72
FINANCIAL REPORTING PROBLEM
(a) 1. Long-lived assets, goodwill
For impairment of goodwill and long-lived assets, fair value is
determined using a discounted cash flow analysis.
2. Short-term and long-term debt
3. Postretirement benefit plans
4. Employee stock ownership plans
(b) 1. The following rates are disclosed in the accompanying notes:
Debt
Weighted-Average Effective Interest Rate
At December 31 2004 2003
Short-Term 1.5% 3.6%
Long-Term 4.0% 3.7%
6-73
FINANCIAL REPORTING PROBLEM (Continued)
Benefit Plans
Pension Benefits
United States
Other Retiree
Benefits
2004 2003 2004 2003
Weighted average
assumptions
Discount rate 5.2% 5.1% 6.1% 5.8%
Expected return on
assets
7.4% 7.7% 9.5% 9.5%
Annual Stock-Based Compensation
Assumptions 2004 2003 2002
Risk-free interest rate 3.8% 3.9% 5.4%
Used in Black-Scholes model.
2. There are different rates for various reasons:
1. The maturity datesshort-term vs. long-term.
2. The security or lack of security for debtsmortgages and
collateral vs. unsecured loans.
3. Fixed rates and variable rates.
4. Issuances of securities at different dates when differing
market rates were in effect.
5. Different risks involved or assumed.
6. Foreign currency differencessome investments and pay-
ables are denominated in different currencies.
6-74
FINANCIAL STATEMENT ANALYSIS CASE
(a) Cash inflows of $350,000 less cash outflows of $125,000 = Net cash
flows of $225,000.
$225,000 X 2.48685 (PVF-OA
3, 10%
) = $559,541.25
(b) Cash inflows of $275,000 less cash outflows of $175,000 = Net cash
flows of $100,000.
$100,000 X 2.48685 (PVF-OA
3,10%
) = $248,685.00
(c) The estimate of future cash flows is very useful. It provides an under-
standing of whether the value of gas and oil properties is increasing
or decreasing from year to year. Although it is an estimate, it does
provide an understanding of the direction of change in value. Also, it
can provide useful information to record a write-down of the assets.
6-75
RESEARCH CASE 1
(a) The Form 10-K items include: (1) Business, (2) Properties, (3) Legal
Proceedings, (4) Submission of Matters to a Vote of Security Holders,
(5) Market for Registrants Common Equity and Related Stockholder
Matters, (6) Selected Financial Data, (7) Managements Discussion
and Analysis of Financial Condition and Results of Operations,
(8) Financial Statements and Supplemental Data, (9) Changes in and
Disagreements with Accountants on Accounting and Financial
Disclosure, (10) Directors and Executive Officers of the Registrant,
(11) Executive Compensation, (12) Security Ownership of Certain
Beneficial Owners and Management, (13) Certain Relationships and
Related Transactions, and (14) Exhibits, Financial Statement Schedules,
and Reports on Form 8-K.
(b) If financials are not included, they have been incorporated by
reference from the annual report to shareholders.
(c) Depends on firm selected.
6-76
RESEARCH CASE 2
(a) FASB pronouncements usually provoke some controversy, and
Concepts Statements are no exception. The principle objections
raised in recent Exposure Drafts are largely the same objections
raised when the Board was deliberating Concepts Statement 7. They
focus on three areas:
1. Use of the expected-cash-flow approach in developing present value
measurements
2. Use of fair value as the objective for measurements on initial
recognition and subsequent fresh-start measurements that employ
present value.
3. Inclusion of the entitys credit standing in the measurement of its
liabilities.
(b) Prior to Concepts Statement 7, many accounting pronouncements
used the term best estimate to describe the target for estimated cash
flows. The term was never defined, but its contexts seem to suggest
that an accounting best estimate is:
1. Unbiased
2. In a range of possible outcomes, the most likely amount
3. A single amount or point estimate.
6-77
RESEARCH CASE 2 (Continued)
Few other professions follow the accounting practice of equating best
estimate and most likely. Statisticians, actuaries, scientists and
engineers tend to avoid the term best estimate. When they use it, they
do so to describe the expected valuethe probability-weighted
average. But accountants have grown used to the most-likely meaning
for best estimate.
The Board has long recognized that present values can be changed
by altering either cash flows or discount rates. Still, the Boards early
deliberations took the traditional path of developing a best estimate of
cash flows and then selecting an appropriate interest rate. Over time,
the Board found that a focus on finding the right interest rate was
unproductive. Any positive interest rate would make the discounted
number smaller than the undiscounted best estimate, but there had to
be more to present value than that. Moreover, it became clear that
intuitions built on contractual cash flows and interest rates dont
always work when applied to assets and liabilities that dont have
contractual amounts and payment dates.
Moving the reference point from contractual to estimated cash flows
disrupts the conventional relationships that apply to contractual cash
flows. What is the rate commensurate with the risk when actual
cash flows may be higher or lower than the best estimate? Is the rate
higher or lower than risk free? By how much? Does the answer
change if the item is a liability rather than an asset? What are the
proper cash flows and interest rate when timing is uncertain? The tradi-
tional approach doesnt provide ready answers to those questions. In
a sense, the drafters of Opinion 21 had it right. If a single best-
estimate of future cash flows and a single interest rate are the only
tools for computing present value, then the technique cannot be
reasonably applied to a broader range of measurement problems.
6-78
RESEARCH CASE 2 (Continued)
(c) The Board was looking at two sets of principles: the elements of
economic value and the practical principles of present value.
The elements of economic value (paragraphs 23 and 39) are:
a. An estimate of the future cash flow, or in more complex cases,
series of future cash flows at different times
b. Expectations about possible variations in the amount or timing
of those cash flows
c. The time value of money, represented by the risk-free rate of
interest
d. The price for bearing the uncertainty inherent in the asset or
liability
e. Other, sometimes unidentifiable, factors including illiquidity and
market imperfections.
The practical principles, stated simply, are:
a. Dont leave anything out. (But see item e.)
b. Use consistent assumptions and dont count the same thing
twice.
c. Keep your finger off the scale.
d. Aim for the average of a range, rather than a single most-likely,
minimum or maximum amount.
e. Dont make up what you dont know.
(d) Most accounting estimates use nominal amounts; the estimate
includes the effect of inflation. The focus here is on Practical Principle
(b)Use consistent assumptions. If the estimated cash flows do not
include inflation, if instead they are real amounts, then the discount
rate should not include inflation. Nominal cash flows are discounted
at a nominal rate, and real cash flows at a real rate.
6-79
PROFESSIONAL RESEARCH: ACCOUNTING AND FINANCIAL REPORTING
Search strings: present value, present and value, Present value$, best estimate, estimated cash
flow, expected cash flow, fresh-start measurement, interest methods of allocation
(a) Statement of Financial Accounting Concepts No. 7, Using Cash Flow Information and Present
Value in Accounting Measurements (FASB 2000).
(b) See Appendix B: APPLICATIONS OF PRESENT VALUE IN FASB STATEMENTS AND APB
OPINIONS, CON7, Par. 119
119. . . . The accompanying table is presented to assist readers in understanding the differences
between the conclusions reached in this Statement and those found in FASB Statements and
APB Opinions that employ present value techniques in recognition, measurement, or amortization
(period-to-period allocation) of assets and liabilities in the statement of financial position. Some
example are:
Debt payable and related premium or discount
Asset acquired by incurring liabilities in a business combinationAn asset acquired by
incurring liabilities is recorded at costthat is, at the present value of the amounts to be paid
(paragraph 67(b)).
APB Opinion No. 21, Interest on Receivables and PayablesNote exchanged for property,
goods, or services.
Capital lease or operating lease . . . The lessees incremental borrowing rate is used unless
(a) the lessors implicit rate can be determined and (b) the implicit rate is less than the
incremental borrowing rate.
FASB Statement No. 91, Accounting for Nonrefundable Fees and Costs Associated with
Originating or Acquiring Loans and Initial Direct Costs of Lease . . . Origination fees and costs
are reflected over the life of the loan as an adjustment of the yield on the net investment in the
loan.
FASB Statement No. 106, Employers Accounting for Postretirement Benefits Other Than
Pensions . . . Effective settlement rate
. . . as opposed to settling the obligation, which incorporates the insurers risk factor,
effectively settling the obligation focuses only on the time value of money and ignores the
insurers cost for assuming the risk of experience losses (paragraph 188).
FASB Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-
Lived Assets to Be Disposed Of . . . The objective is to estimate the fair value of the impaired
asset. . . . The objective is to estimate fair value.
(c) 1. CON7, Glossary of terms: Best estimate: The single most-likely amount in a range of possible
estimated amounts; in statistics, the estimated mode. In the past, accounting pronouncements
have used the term best estimate in a variety of contexts that range in meaning from
unbiased to most likely. This Statement uses best estimate in the latter meaning, as
distinguished from the expected amounts described below.
2. CON7, Glossary of terms: Estimated Cash Flow and Expected Cash Flow: In the past,
accounting pronouncements have used the terms estimated cash flow and expected cash flow
interchangeably. In this Statement: Estimated cash flow refers to a single amount to be
received or paid in the future. Expected cash flow refers to the sum of probability-weighted
amounts in a range of possible estimated amounts; the estimated mean or average.
6-80
ACCOUNTING AND FINANCIAL REPORTING (Continued)
3. CON7, Glossary of terms: Fresh-Start Measurements: Measurements in periods following
initial recognition that establishes a new carrying amount unrelated to previous amounts and
accounting conventions. Some fresh-start measurements are used every period, as in the
reporting of some marketable securities at fair value under FASB Statement No.115,
Accounting for Certain Investments in Debt and Equity Securities. In other situations, fresh-
start measurements are prompted by an exception or trigger, as in a remeasurement of
assets under FASB Statement No. 121, Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to Be Disposed Of.
4. CON7, Glossary of terms: Interest Methods of Allocation: Reporting conventions that use
present value techniques in the absence of a fresh-start measurement to compute changes in
the carrying amount of an asset or liability from one period to the next. Like depreciation and
amortization conventions, interest methods are grounded in notions of historical cost. The
term interest methods of allocation refers both to the convention for periodic reporting and to
the several approaches to dealing with changes in estimated future cash flows.
6-81
PROFESSIONAL SIMULATION
Measurement
i = 12%
Principal
$100,000
Interest
PVOA = ? $10,000 $10,000 $10,000 $10,000 $10,000
0 1 2 3 4 5
n = 5
Present value of the principal
FV (PVF
5, 12%
) = $100,000 (.56743) = $56,743.00
Present value of the interest payments
R (PVFOA
5, 12%
) = $10,000 (3.60478) = 36,047.80
Combined present value (purchase price) $92,790.80
i = 8%
Principal
$100,000
Interest
PVOA = ? $10,000 $10,000 $10,000 $10,000 $10,000
0 1 2 3 4 5
n = 5
Present value of the principal
FV (PVF
5, 8%
) = $100,000 (.68058) = $ 68,058.00
Present value of the interest payments
R (PVFOA
5, 8%
) = $10,000 (3.99271) = 39,927.10
Combined present value (Proceeds) $107,985.10
6-82
PROFESSIONAL SIMULATION (Continued)
12%
Inputs: 5 12 ? 10000 10000
N I PV PMT FV
Answer: 92,790.45
8%
Inputs: 5 8 ? 10000 10000
N I PV PMT FV
Answer: 107,985.42
Valuation
A B C D E F G
1
2 Bond Amortization Schedule
3
4 Date Cash Interest
Interest
Expense
Bond Discount
Amortization
Carrying
Value of
Bonds
5 Year 0 $92,790.45
6 Year 1 10,000.00 $11,134.85 $1,134.85 93,925.30
7 Year 2 10,000.00 11,271.04 1,271.04 95,196.34
8 Year 3 10,000.00 11,423.56 1.423.56 96,619.90
9 Year 4 10,000.00 11,594.39 1,594.39 98,214.29
10 Year 5 10,000.00 11,785.71 1,785.71 100,000.00
11
12
13
14
15
The following formula is
entered in the cells in
this column: =+E5*0.12.
The following formula is
entered in the cells in this
column: =+C6-B6.
The following formula is
entered in the cells in this
column: =+E5+D6