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510chapter6fall2009bb

# 510chapter6fall2009bb - C ha pter 6 Accounti ng a nd the T...

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Chapter 6: Accounting and the Time Value of Money

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What’s Important Future value of a single sum Present value of a single sum Solving for other unknowns Basic Time Value Concepts Single-Sum Problems Annuities More Complex Situations The nature of interest Simple interest Compound interest Fundamental variables Future value of ordinary annuity Future value of annuity due Present value of ordinary annuity Present value of annuity due Valuation of long-term bonds
In accounting (and finance), the term indicates that a dollar received today is worth more than a dollar promised at some time in the future. Basic Time Value Concepts Time Value of Money MONEY NOW ??? MONEY LATER???

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1. Notes 2. Leases 3. Pensions and Other Postretirement Benefits 4. Long-Term Assets Accounting Applications 1. Sinking Funds 2. Business Combinations 3. Disclosures 4. Installment Contracts
Payment for the use of money. Excess cash received or repaid over the amount borrowed (principal). Variables involved in financing transaction: 1. Principal - Amount borrowed or invested. 2. Interest Rate - A percentage. 3. Time - The number of years or portion of a year that the principal is outstanding. Nature of Interest Basic Time Value Concepts

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Interest computed on the principal only. Simple I nterest ILLUSTRATION: On January 2, 2010, Tomalczyk borrows \$20,000 for 3 years at a rate of 7% per year. Calculate the annual interest cost. Principal \$20,000 Interest rate x 7% Annual interest \$ 1,400 Federal law requires the disclosure of interest rates on an annual basis in all contracts. FULL FULL YEAR YEAR
Simple I nterest ILLUSTRATION continued: On March 31, 2010, Tomalczyk borrows \$20,000 for 3 years at a rate of 7% per year. Calculate the interest cost for the year ending December 31, 2010. Principal \$20,000 Interest rate x 7% Annual interest \$ 1,400 Partial year x 9/ 12 Interest for 9 months \$ 1,050 PARTIAL PARTIAL YEAR YEAR

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Computes interest on the principal and on interest earned to date (assuming interest is left on deposit). Compound interest is the typical interest computation applied in business situations. Compound Interest
Illustration: Illustration: Tomalczyk Company deposits \$10,000 in the Last Tomalczyk Company deposits \$10,000 in the Last National Bank, where it will earn simple interest of 9% per year. It National Bank, where it will earn simple interest of 9% per year. It deposits another \$10,000 in the First State Bank, where it will earn deposits another \$10,000 in the First State Bank, where it will earn compound interest of 9% per year compounded annually. In both compound interest of 9% per year compounded annually. In both cases, Vasquez will not withdraw any interest until 3 years from the cases, Vasquez will not withdraw any interest until 3 years from the date of deposit. date of deposit. Year 1 \$10,000.00 x 9% Year 1 \$10,000.00 x 9% \$ 900.00 \$ 10,900.00 Year 2 \$10,900.00 x 9% Year 2 \$10,900.00 x 9% \$ 981.00 \$ 981.00 \$ 11,881.00 \$ 11,881.00 Year 3 \$11,881.00 x 9% Year 3 \$11,881.00 x 9% \$1,069.29 \$1,069.29 \$ 12,950.29 Basic Time Value Concepts Basic Time Value Concepts

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Compound I nterest Tables Table 1 - Future Value of 1 Table 2 - Present Value of 1 Table 3 - Future Value of an Ordinary Annuity of 1 Table 4 - Present Value of an Ordinary Annuity of 1 Table 5 - Present Value of an Annuity Due of 1 Five Tables in Chapter 6
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