Unit 8
Unit 8
Unit 8
Contents
8.0 Aims and Objectives
8.1 Introduction
8.2 The Time Value of Money
8.3 Uses of Present and Future Values in Financial Accounting
8.4 Simple Interest and Compound Interest
8.5 Future and Present Values
8.5.1 Future Value of a Single Sum
8.5.2 Present Value of a Single Sum
8.6 Annuities
8.6.1 Amount of Annuities
8.6.1.1 Amount of Ordinary Annuity
8.6.1.2 Amount of Annuity Due
8.6.1.3 Amount of Deferred Annuity
8.6.2 Present Value of Annuities
8.6.2.1 Present Value of Ordinary Annuity
8.6.2.2 Present Value of Annuity Due
8.6.2.3 Present Value of Deferred Annuity
8.7 Summary
8.8 Answers to Check Your Progress
8.9 Model Examination Questions
8.10 Glossary
8.11 Appendix: Compound Interest Tables
The aims of this unit are to discuss the essentials of compound interests, annuities and
present value, and to provide a sufficient background for application of these techniques.
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After you have studied this unit, you will:
understand the time value of money, which underlines all interest calculations
and a wide range of accounting issues.
know how to compute future and present values of both single payments and
annuities
understand the distinction between an ordinary annuity, an annuity due and
deferred annuity
be able to solve valuation problems by combining present and future value
computations for single payments and annuities.
8.1 INTRODUCTION
Compound interest, annuity and present value techniques can be applied to many of the
items found in financial statements.
In accounting, these techniques can be used to measure the relative values of cash inflows
and outflows, evaluate alternative investment opportunities, and determine periodic
payments necessary to meet future obligations. Some of the accounting items to which
these techniques may be applied are notes receivables and payable, leases, amortization
of premium and discounts etc.
In general business terms, interest is defined as the cost of using money overtime. This
definition is in close agreement with the definition used by economists, who prefer to say
that interest represents the time value of money.
Ignoring the effects of inflation, a dollar to day is worth more than a dollar to be received
a year from now. In other words, we would all prefer to receive a specific amount of
money now rather than on some future date. This preference rests on the time value of
money. When payments for the time value of money are made or accrued interest
expense is incurred, when payments for the time value of money are received or accrued,
interest revenue is realized.
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Inflows of dollars on various future dates should not be added together as if they were of
equal value. These future cash inflows must be restated at their present values before they
are aggregated. The concept of the time value of money tells us that more distant cash
inflows have a smaller present value than cash inflows to be received within a shorter
time span.
Similar reasoning applies to cash outflows. Before we add together cash outflows on
various future dates, we must restate these outflows at their present values. The more
distant the date of a cash outflow, the smaller is its present values.
As a simple example of this concept of present value, assume that you are trying to sell
your car and you receive offers from three prospective buyers.
Buyers A offers you Br. 8000 to be paid immediately. Buyer B offers you Br. 8,200 to be
paid one year from now. Buyer C offers the highest price, Br. 9,200 but this offer
provides that payment will be made in five years. Assuming that the offers by B and C
involves no credit risk and that money may be invested at 5% interest compounded
annually, which offer would you accept?
You should accept the offer of Br. 8000 to be received immediately, because the present
value of the other two offers is less than Br. 8000. if you were to invest Br. 8000 today,
even at the modest rate of interest of 5%, your investment would be more than Br. 8200
in one year and considerably more than Br. 9,200 in five years.
This example suggests that the timing of cash receipts and payments has an important
effect on the economic worth and the accounting values of both assets and liabilities.
Consequently, investment and borrowing decisions should be made only after a careful
analysis of the relative present values of the prospective cash inflows and outflows.
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8.3 USES OF PRESENT AND FUTURE VALUES IN FINANCIAL ACCOUNTING
Interest is the excess of resources (usually cash) received or paid over the amount of
resources loaned or borrowed at an earlier date. Business transactions subject to interest
state whether simple or compound interest is to be calculated.
Simple interest is the return on a principal amount for one time period. We may also
think of simple interest as a return for more than one time period if we assume that the
interest itself does not earn a return, but this kind of situation occurs rarely in the business
world. Simple interest usually is applicable only to short-term investment and borrowing
transactions involving a time span of less than one year.
Interest generally is expressed in terms of an annual rate. The formula for simple interest
is:
I = p.r.t (interest = principal x annual rate of interest x number of years or fraction of a
year that interest accrues). For example, interest on Br. 10,000 at 8% for one year is
expressed as follows:
I = p.r.t
I = Br. 10,000 x 0.08 x 1
I = Br. 800
Compound interest is the return on a principal amount for two or more time periods,
assuming that the interest for each time period is added to the principal amount at the end
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of each period, and earns interest in all subsequent periods. Because most investment and
borrowing transactions involve more than one time period, business executives evaluate
proposed transactions in terms of periodic returns, each of which is assumed to be
reinvested to yield additional returns.
N.B, In the computation of compound interest, the accumulated amount at the end of
each period becomes the principal amount for purposes of computing interest for the
following period.
Future value involves a current amount that is increased in the future as a result of
compound interest accumulation. Present value, in contrast, involves a future amount that
is decreased to the present as a result of compound interest discounting. Discounting, in
effect, extracts the interest from a future value thereby returning to the principal amount.
The fact that investments have starting points and ending points makes it easier to
understand present and future values. Present value in general refers to dollar (birr)
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values at the starting point of an investment, and future value refers to end-point dollar
(birr) values.
If the dollar (birr) amount to be invested at the start is known, the future value of that
amount at the end can be projected, provided the interest rate and number of interest
compounding periods are also specified. Similarly, if the dollar (birr) amount available at
the end of an investment period (future value) is known, the amount of money needed at
the start of the investment period (present value) can be determined, again if the interest
rate and number of interest compounding periods are known.
Present value and future value apply to interest calculations on both single payment
amounts and periodic equal payment amounts (annuities)
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n i
Tables are available that give the value of a n
Use of these tables involves reference to a line showing the number of periods and a
column showing the rate of interest per period.
Solution: The amount in the savings account on the daughter’s 18 th birthday will be Br.
10,000 (1 + 0.025)72. Because Table 1 in the Appendix at the end of the chapter does not
go beyond 50 periods, the amount in the savings account on the daughter’s 18 th birthday
may be computed as follows:
Br. 10,000 (1 + 0.025) 50 x (1 + 0.025) 22
Br. 10,000 (3.437109) x (1.721571) = Br. 59,172
Example 1.
1. If Br. 1000 is deposited at compound interest on January 1, 1990, and the
amount on deposit on December 31, 1999 is Br. 1806.11, what is the semiannual interest
rate accruing on the deposit?
Solution: The amount of 1 for 20 periods at the unstated rate of interest is 1.80611 (Br.
1806.11 Br. 1000 = 1.80611). Reference to table 1 in the Appendix at the end of this
chapter indicates that 1806111 is the amount of 1 for 20 periods at 3%. Therefore, the
semiannual interest rate is 3%.
Example 2.
2. A family can invest Br. 150,000 today to provide for the college education of
their child. The family believes that Br. 285,000 will be necessary for four years of
college by the time the student matriculates. If the family can invest at 6% how many
years will it take to accumulate Br. 285,000?
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Solution:
1. Br. 285,000 = Br. 150,000 (1 + 6%)n
Br. 285,000 150,000 = 1.9000, which is the value in Table 1 of Br. 1 at 6%
interest.
2. In Table 1, read down the 6% column to find 1.9000.
3. The table value 1.89830 is found on the line for 11 years and the value 2.01220 is
found on the line for 12 years.
4. The number of interest periods is just over 11 years
The computation of the present value of a single future amount is a reversal of the
process of finding the amount to which a present amount will accumulate. We know that
a = p (1 + i)n, and when we solve for p by dividing both sides of the equation by (1 + i) n,
we have p =
Therefore, the formula for the present value of a due in n periods at i rate of interest per
period is
ni =
P n a = future amount
P = present value
i = interest rate per period
n = number of compounding period
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Example: If we want an amount of Br. 30,000 after 12 years by making a single deposit
in a saving account which will pay 16% interest compounded quarterly, what should the
amount of initial deposit be?
Solution: The present value is Br. 30,000 discounted at 4% for 48 periods. Using Table 2
in the Appendix at the end of this chapter, the present value is
Br. 30,000 x 0.152195 = Br. 4565.84
Or using the formula:
P= = = Br. 4565.84
Example: If the present value of Br. 100,000 discounted at an unstated rate of interest for
20 periods is Br. 64,162.10, what was the approximate interest rate per period used in
computing this present value?
Solution: From Table 2 in the Appendix at the end of this chapter, we obtain the
following present values for different interest rates:
202% = 0.672971
P 20 20? % = 0.641621
P 20 2021/2% = 0.610271
P 20
difference = 0.03135
difference = 0.06270
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Check your progress – 4
1. ADDIS Co. wants to deposit cash in a saving account at the beginning of year 1
so that it will have Br. 50,000 at the end of year 6. How much must the company
deposit at the beginning of year 1 if the interest rate is 6% computed semiannually
for the first three years and 8% compounded quarterly for the next three years?
__________________________________________________________________
__________________________________________________________________
________________________________________.
8.6 ANNUITIES
When rents are paid or received at the end of each period and the total amount on deposit
is determined at the time the final rent is made, the annuity is an ordinary annuity (or
annuity in arrears). When rents are paid or received at the beginning of each period, and
the total amount on deposit is determined one period after the final rent, the annuity is
annuity due (or annuity in advance). When the amount of an ordinary annuity remains on
deposit for a number of period beyond the final rent, the arrangement is known as a
deferred annuity.
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The difference between the three types of annuity is illustrated below:
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Example: Compute the amount of an ordinary annuity of 16 rents of Br. 100 at 2%
Solution: A = Br. 100
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Example: Green Company needs Br. 200,000 on March 31, year 5. This amount is to be
accumulated by making 16 equal deposits in a fund at the end of each quarter, starting
March 31, year 1,and ending on December 31, year 4. The fund will earn interest at 8%
compounded quarterly. Compute the periodic rents (deposits) that Green Company must
make.
Solution: The balance in the fund on March 31, year 5, represents the amount of an
annuity due of 16 rents at 2% per period (19.01207 as determined above). Therefore, the
periodic rents are: Br. 200,000 19.01207 = Br. 10,519.63. This result may be verified
as follows:
Amount of ordinary annuity of 16 rents of Br. 10,519.63 at 2% on December 31,
year 4: Br. 10,519.63 x 18.639285 ------------------------------------------Br. 196,078
Add: Interest for first quarter of year 5 Br. 196,078 x 0.02 ---------------------3,922
---------------------3,922
Balance in fund on March 31, year 5 (amount of
an annuity due of 16 rents of Br. 10,579.63 at 2%) -----------------------Br. 200,000
The amount of a deferred annuity may be computed by multiplying the amount of the
ordinary annuity by the amount of 1 for the period of deferral to accrue compound
interest.
Alternatively, we may take the amount of an ordinary annuity for all periods (including
the period of deferral) and subtract from this the amount of the ordinary annuity for the
deferral period when rents were not made, but interest continued to accumulate.
Example: On April 1, 1996 Delta company decided to accumulate cash to pay a debt,
that matures on March 31,2002. The company deposited Br. 10,000 cash on March 31,
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1996, 1997 and 1998. The interest rate is 10 percent compounded annually. Determine
the amount that will accumulate on March 31, 2002.
Solution: using the Appendix at the end of this chapter, the amount of an ordinary
annuity of three rents deferred for 4 periods may be computed as: Br. 10,000 x 3.31 x
1.4641 = Br. 48,461.71
Present value of annuities are used more frequently in financial accounting. For example,
the computation of the proceeds of bond issues, the value of plant assets acquired in
purchase type business combination or through capital leases, the amount of past service
pension costs, the amount of debt or receivables under installment contracts, and the
amount of mortgage debt or investments in mortgage notes all require the application of
the present-value- of annuity concept.
A diagram depicting the present value (P) of an ordinary annuity of five rents (R) is given
below:
Present value of an ordinary annuity of 5 rents of 1
in table 4 of Appendix is for this point in time.
Rents R R R R R
1st 2nd 3rd 4th 5th
0 1 2 3 4 5
The present value of an ordinary annuity of five rents depicted above is the value of the
rents, discounted at compound interest, at a point in time one period before the first rent.
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The present value of an ordinary annuity is computed as the total of the present values of
the individual rents, but the use of a table, such as Table 4 in the Appendix at the end of
this chapter is more efficient. The present value of an ordinary annuity may be computed
using the following formula.
P=R
Example: ERA company has outstanding a Br. 500,000 non interest bearing debt,
payable Br. 100,000 a year for five years starting on December 31, year 1. what is the
present value of this debt on January 1, year 1, for financial accounting, if 8%
compounded annually is considered a fair rate of interest?
Solution: The present value of the debt on January 1, year 1, is equal to the present value
of an ordinary annuity of five rents reported at Br. 399,271 (Br. 100,000 x 3.99271) in the
accounting records on January 1, year 1.
The repayment program (loan amortization table) for this debt is summarized below:
ERA Company
Repayment program for Debt of Br. 399,271 at 8% interest
Interest Expense Repayment at Net reduction Debt balance
Date at 8% a year end of year in debt
Jan. 1, year 1 Br. 399,271
Dec. 31, year 1 Br. 31,942 Br. 100,000 Br. 68,058 331, 213
Dec. 31, year 2 26,497 100,000 73,503 257,710
Dec. 31, year 3 20,617 100,000 79,383 178,327
Dec. 31, year 4 14,266 100,000 83,734 92,593
Dec. 31, year 5 7,407 100,000 92,593 –0-
Example 2
NINI corporation issued Br. 5 million face value amount of 9% five year bonds on June
30, year 5. The bonds pay interest on June 30 and December 31 and were issued to yield
10% compounded semiannually. Compute the proceeds of this bond issue.
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Solution:
The proceeds of the bond issue may be computed as the total of (1) the present value of
the Br. 5 million to be paid at maturity, discounted at the 5% semiannual current rate of
interest for 10 periods, plus (2) the present value of an ordinary annuity of 10 rents of Br.
225, 000 (Br. 5,000,000 x 0.045 = Br. 225,000) semiannual interest payments, also
discounted at 5% per period. That is,
Present value of Br. 5 million discounted at 5% for 10 six
month periods: Br. 5,000,000 x 0.613913 -------------------------------Br. 3,069,565
Add: present value of ordinary annuity of 10 rents
of Br. 225,000 discounted at 5% Br. 225,000 x 7.721735 -------------1,737,390
Proceeds of bond issue ------------------------------------------------------Br. 4,806,955
Example 3:
On June 30, year 1, Levine Corporation purchased merchandise at an auction for Br.
40,000. The current fair value of the merchandise according to Levine personnel was at
least Br. 48,000. Levine paid Br. 1,200 payable on the note quarterly, starting on
September 30,year 1. You conclude that the current fair rate of interest on the note is 12%
payable quarterly.
Required: Record the purchase of the merchandise in the accounting records of Levine
Corporation, assuming that the periodic inventory system is used.
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Solution: The journal entry for Levine Corporation on June 30, year 1:
Purchases ---------------------------------41,115
Cash ----------------------------------------------10,000
Notes payable -----------------------------------30,000
Premium on Notes payable ----------------------1115
N.B.
N.B. The premium on the note payable is determined as follows:
Interest of Br. 1,200 is paid quarterly, but the current fair rate of interest should be Br.
900 quarterly. Therefore, the premium on the note payable is equal to the present value of
an ordinary annuity of four rents of Br. 300 (the excessive interest) at 3% per quarter (Br.
300 x 3.717098 = Br. 1,115).
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Present value of annuity due of 5 rents
Rents R R R R R
1st 2nd 3rd 4th 5th
0 1 2 3 4 5
The diagram above indicates that the present value at time period 1 of an annuity due of
five rents may be computed
(1) By adding interest for one period to the present value of an ordinary annuity of
five rents, or
(2) By obtaining the present value of an ordinary annuity of four rents and then
adding 1, representing the ‘extra’ rent at time period 1.
Example: On January 1, year 1, Sosa corporation acquired a plant asset for Br. 64,682.
Sosa agreed to make five equal annual payments starting on January 1, year 1, and ending
on January 1, year 5, at 8% compounded annually. Compute the annual payments on the
debt.
Solution: The annual payments on the debt are present value (Br. 64,682) divided by
present value of annuity due of at 8% for 5 periods (4.312127) = Br. 15,000
Example 2
Fox company purchased Machinery on January 1, 19x1 and agreed to pay for the
purchase with four payments of Br. 6000 each, including interest and principal, every six
months beginning on January 1, 19x1. The agreed interest rate is 8% compounded
semiannually.
Required:
1. Compute the price of the machinery (excluding interest charges)
2. Prepare journal entries related to the purchase
Solution:
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1) The price of the machinery means the present value of future payments. The series of
future payments form annuity due, and the present value of the annuity due is calculated
as Br. 6000 x 3.62895 x 1.04
= Br. 22,651
2) The journal Entry to be recorded for the purchase of machinery is
method 1 method 2
19x1 Equipment ---------22,651 or Equipment -----------22,651
January 1 Accounts payable ------22,651 Discount on N/Payable 1349
Accounts payable ------24,000
The journal entries to record payments every six months are
19x1 A/payable ------------6000
Jan. 1 Cash ----------------------6000
19x1 A/payable --------------5334 A/payable ---------6000
July 1 Interest Expense -------666 Interest Exp.------- 666
Cash ---------------------6000 Cash --------------------6000
Discount on N/pay. ----666
19x2 A/payable --------------5547 A/payable -----------6000
Jan. 1 Interest Expense ------453 Interest Expense ----453
Cash --------------------6000 Cash --------------------6000
Discount on N/payable 453
19x2 A/payable ---------------5770 A/payable ----------6000
July 1 Interest Expense --------230 Interest Expense ----230
Cash ------------------6000 Cash -------------------6000
Discount on N/payable 230
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1) discount the present value of the ordinary annuity portion at compound interest
for the period the annuity is deferred, or
2) determine the present value of an ordinary annuity equal to the total number of
period involved and subtract from this the present value of the “missing” ordinary
annuity for rents equal in number to the number of periods the annuity is deferred.
Example: Daof Company wants to know the amount at time period 0 that would pay a
debt of five payments of Br. 100,000 each, payments starting at time period 4, and
interest compounded at 8% per time period.
Solution: Using Table 2 and 4 in the Appendix at the end of this chapter, we may
compute the present value at time period 0 (today) of the ordinary annuity of five rents of
1 deferred for three periods as follows:
(1) Present value of ordinary annuity of five rents of
1 at 8% at time period 3, discounted at 8% for
three periods: 3,992710 x 0.793832 --------------------------------------------3.169541
--------------------------------------------3.169541
or (2) present value of ordinary annuity of eight rents
of 1 at 8% at time period 0, less the present value of
ordinary annuity of three rents of 1 (the rents note made)
at 8% at time period 0.5.746639 – 2.577097 -------------------------------------3169542
-------------------------------------3169542
Thus, cash in the amount of Br. 316,954 (Br. 100,000 x 3.169542) is needed at time
period 0 to repay the debt.
The repayment of debt is summarized below:
Daof Company
Repayment program for debt of Br. 316,954 at 8% interest
Time period Interest Expense Repayment Net reduction Debt
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at 8% per period in debt Balance
0 present value of Br. 316,954
1 debt 342,310
2 Br.25,356 369,695
3 29,576 399,271
4 31,942 --------------------Br. 100, 000-------Br. 68, 058 331,213
5 26,497----------------------- 100, 000------- 73, 503 257,710
6 20,617----------------------- 100, 000------- 79, 383 178,327
7 14,26617-------------------- 100, 000------- 85, 734 92,593
8 7,407------------------------ 100, 000------- 92, 593 0
8.7 SUMMARY
The concepts of present value is described as the amount that must be invested now to
produce a known future value. This is the opposite of the compound interest discussion in
which the present value was known and the future value was determined.
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of an annuity for a given set of facts, there will be one less interest period for an ordinary
annuity than for an annuity due.
A deferred annuity is an annuity in which two or more periods must pass, after it has been
arranged, before the rents will begin. For example, an ordinary annuity of 10 annual rents
deferred five years mean that no rents will occur during the first five years, and that the
first of the 10 rents will occur at the end of the sixth year.
An annuity due of 10 annual rents deferred five years means that no rents will occur
during the first five years, and that the first of the 10 rents will occur at the beginning of
the sixth year.
In general, compound interest, annuity and present value techniques can be applied to
many of the items found in financial statements. In accounting, these techniques can be
used to measure the relative values of cash inflows and outflows, evaluate alternative
investment opportunities, and determine periodic payments necessary to meet future
obligations. Some of the accounting items to which these techniques may be applied are
notes receivable and payable, leases, amortization of premium and discounts etc.
1. Time value of money means that a dollar in hand today is worth more than a
dollar to be collected one year from now, because it can earn interest.
2. Simple interest is computed on the same principal amount each period.
Compound interest is computed on the principal amount and on all prior interest
credited and not paid or withdrawn.
3. Using Table 1 in the Appendix at the end of this chapter, we have the following at
the end of four years at 8% interest compounded quarterly
162% = Br. 10,000 (1 + 0.02) 16
Br. 10,000 x a16
= Br. 10,000 (1.372786)
= Br. 13,728
And for the next six years at 10% compounded semiannually, we have:
125% = Br. 13,728 (1 + 0.05)12
Br. 13,728 x a12
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= Br. 13,728 (1.795856)
= Br. 24,654
Therefore, at the end of 10 years, FAR Co. will have Br. 24,654 in the fund.
4. Using Table 2 in the Appendix at the end of this chapter, we have the following
present value at the beginning
122% = Br. 50,000 x 0.788493 = Br. 39,425
Br. 50,000 x P 12
And at the beginning of year 1 we have:
63% = Br. 39,425 x 0.837484 = Br. 33,018
Br. 39,425 x P 6
Thus, Addis Company must deposit Br. 33,018 at the beginning of year 1 to have Br.
50,000 at the end of year 6.
5. i. Br. 9320 Br. 500 = 18.64, the amount of an ordinary annuity of 1 at 2% for
an unknown number of rents. The 2% column in Table 3 in the Appendix at the
end of this chapter shows that the required number of rents is 16 because the
amount of an ordinary annuity of 16 rents at 2% is 18.64
ii.Br. 9320 Br. 500 = 18.64, the amount of an ordinary annuity of 16 rents of 1 at
an unstated interest rate per period. The line for 16 rents in Table 3 in the Appendix
at the end of this chapter shows that the interest rate per period is 2%
iii. Table 3 in the Appendix shows that the amount of an ordinary annuity of 16 rents
at 2% is 18.64 (rounded). The periodic rents are Br. 500 (9,320 18.64)
6. i. d
ii. d
7. Present value of deferred annuity is the discounted value of a series of future rents
on a date that is more than one period before the date that the first rent is received
or paid. When the present value is determined on the date the first rent is made, it
is annuity due. When the present value is determined one period before the first
rent is made, it is an ordinary annuity.
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I. True/False
_________ 1. Present value techniques can be used in valuing receivables and payables
that carry no stated interest rate.
_________ 2. The major difference between compound interest and simple interest lies in
the fact that compound interest is computed twice each year, whereas
simple interest is computed only once.
_________ 3. An annuity requires that periodic rents always be the same even though the
interval between the rents may vary.
_________ 4. The number of rents exceeds the number of discount periods under the
present value of an ordinary annuity.
_________ 5. The future amount of a deferred annuity is normally greater than the future
amount of an annuity not deferred.
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__________ 4. An asset has a cash price of Br. 9,593.37. The purchaser agrees to pay Br.
2000 down and 4 annual payments of Br. 2500 at the end of each year.
Assuming compounding on an annual basis, what is the stated interest
rate of this transaction?
A. 12% B. 5% C. 6% D. 15% E. None
__________ 5. How much must be invested at the end of each year to accumulated a
fund of Br. 50,000 at the end of 10 years, if the fund earns 9% interest,
compounded annually?
A. Br. 5000 B. Br. 3,291 C. Br. 4,200 D. Br. 1519 E. None
__________ 6. Present values of an ordinary annuity of 1 at 15% a year compounded
annually are as follows: n = 5,352155; n = 6,3.784483; n = 7,4.160420.
the present value of an annuity due of 6 rents of at 15% a year
compounded annually is:
A. 3.784483 B. 4.352155 C. 3.60420 D. None
III. Exercises
1. Northern Airlines is negotiating to acquire four new Airbus planes. Three alternatives
are available:
A. Purchase the aircraft for Br. 35 million each, payment
B. Purchase the aircraft by paying Br. 20 million immediately and Br. 20 million
each year for 11 more years.
C. Lease the aircraft for Br. 21.5 million payable at the end of each year for 12 years.
The relevant market rate of interest (the discount rate) for ventures of this type is
10 percent. Assuming that Northern has sufficient resources, which alternative is
least expensive? Ignore tax considerations.
2. Rapid construction company can purchase a used machine for Br. 30,000. the machine
will be needed on a new job that will continue for approximately three years. It is
January 1, 1990, and the machine is needed immediately. Because of a shortage of
cash, rapid has asked the vendor for credit terms. The vendor charges 11 percent
annual compound interest. The machine can be purchased under these terms by
making three equal payments.
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Required:
1. Compute the amount of the three equal payments assuming that they are to be
paid on (a) January 1 and (b) December 31. if your answers are different,
explain why
2. Prepare a debt payment schedule for (a) and (b) above
3. Give the journal entries for (a) and (b) through year 3 Date each entry. Assume
that Rapid’s reporting year-ends
4. What amount should be recorded as the cost of the machine in (a) and (b)
above?
3. Zoltar moving company has decided to accumulate a debt retirement fund by making
three equal annual deposits of Br. 15,000 beginning on December 31, 2000. Assume
that the fund will accumulate annual compound interest at 7% per year, which will be
added to the fund balance.
Required: 1. What kind of annuity is this? Explain
2. What will be the balance in the fund in three years (immediately after
the last deposit)?
3. Prepare an accumulation schedule for this fund
4. Prepare the journal entries for the three-year period. Assume that
Zoltar’s reporting year ends on December 31
5. What would be the balance in the fund at the end of the three years if it
were set up on an annuity due basis?
4. On December 31, year 1, long company issued Br. 10 million of 8% bonds payable.
Interest is payable on December 31 of each year. The bonds mature on December 31,
year 11. The bonds were issued to yield an annual rate of 10%. The present value of
an ordinary annuity of 10 rents of 1 at 10% is 6.144567; the present value of 1 for 10
periods at 10% is 0.385543
Compute the amount received from issuance of the bonds.
5. Strong Tools company will establish a special debt retirement fund amounting to Br.
100,000. a trustee has agreed to handle the fund and to increase it each year on a 20
percent annual compound interest basis. Strong Tools will make equal annual
contributions to the fund during the next four years, starting in 2000
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Required:
1. Compute the amount of the required annual deposit assuming that they are
made on
a) December 31 and
b) January 1. If your answers are different, explain why?
2. Prepare a fund accumulation schedule for each starting date (a) and (b) above
3. Give the journal entries related to each starting date for all four years. Date
each entry. Assume that strong tools reporting year-ends on December 31.
8.10 GLOSSARY
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ani = (1 + I)n
Table 1: Future amount of 1, an
pni =
Table 2: Present value of 1, pn
ni =
A n
ni =
P n
N.B.
N.B. Compound interest tables generally are prepared for Br. 1 and the birr (dollar) sign
is omitted. This provides a convenient means of finding the accumulated amount of any
number of birr (dollar) by multiplying the amount of 1 at i interest for n periods by the
number of birrs (dollars) involved in a problem of a business transaction.
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