Chapter_6_Lecture

Chapter_6_Lecture - LECTURE I imagine that most of you have...

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LECTURE I imagine that most of you have had previous exposure to single sum problems and ordinary annuities, but annuities due and deferred annuities will be new material for most of you. Illustration 6-5 can be used to understand how to solve any annuity problem. It uses 10 sample problems to demonstrate a 4-step solution method that can be used to solve any of the problems discussed in the appendix. A. Introduction. 1. The importance of the time value of money. Money has a time value. Time value means that a dollar is worth more now than a dollar one year from now, because one dollar held today can be invested to earn interest or some other form of return and thus will be more than one dollar one year from now. 2. Accounting applications of time value concepts: bonds, pensions, leases, long-term notes. 3. Personal applications of time value concepts: purchasing a home, planning for retirement, evaluating alternative investments. B. Nature of Interest. 1. Interest is payment for the use of money. It is the excess cash received or repaid over and above the principal (amount lent or borrowed). 2. Interest rates are generally stated on an annual basis unless indicated otherwise. 3. Choosing an appropriate interest rate: a. is not always obvious.
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b. three components of interest: (1) pure rate of interest (2%–4%). (2) credit risk rate of interest (0%–5%). (3) expected inflation rate of interest (0%–?%). C. Simple Interest. Review Illustration 6-1 to distinguish between simple interest and compound interest. 1. Simple interest is computed on the amount of the principal only. 2. Simple interest = p x i x n where p = principal. i = rate of interest for a single period. n = number of periods. D. Compound Interest. 1. Compound interest is computed on the principal and on any interest earned that has not been paid or withdrawn. 2. The power of time and compounding. (E.g., “What do the numbers mean?” on text page 255 indicates that at 6% compounded annually, $24 grows to $79 billion in 376 years. At 6% simple interest, $24 would grow to only $565.44 in 376 years.) $565.44 = $24 + ($24 x .06 x 376). 3. The term period should be used instead of years. a. Interest may be compounded more than once a year: If interest is Number of compounding compounded periods per year Annually 1 Semiannually 2 Quarterly 4 Monthly 12 b. Adjustment when interest is compounded more than once a year. (1) Compute the compounding period interest rate: divide the annual interest rate by the number of compounding periods per year.
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(2) Compute the total number of compounding periods: multiply the number of years by the number of compounding periods per year. E. Terminology Used in Compound Interest Problems. 1.
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Chapter_6_Lecture - LECTURE I imagine that most of you have...

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