Lecture16 2010.11.10 PostClass

Lecture16 2010.11.10 PostClass - Lecture 16 Accounting for...

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Lecture 16 Accounting for Long Term Debt
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Today’s Outline • Time value of money – Present value of $1 – Present value of $1 annuity • Current Liability • Long Term Debt – Principal and Interest – Types of long term debt • Accounting Issues – Note Payable – Mortgages
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Time Value of Money • You are given the choice of $1 today or $1 a year from now. What do you prefer and why? • Formula FV = PV(1+r) t FV is Future Value PV is Present Value r is the interest rate per period t is the number of periods over which interest is compounded Note that r and t have to be in same units
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4 Future Value – The amount a specified investment (i.e., $1) will be worth at a future date if it earns a given compound interest rate – i.e. amount accumulated including interest and principal Example : If a person puts $100,000 in a bank account that pays 8% interest per year for 3 years, the future value is Future Value FV = $100,000 * (1+0.08) 3 = $125,971.20
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Present Value What is the value to you today of obtaining $100 at the end of one year? Receive $100 Today Depends on the interest rate at which you could invest the money Assuming 5%, then the value today is $100 / 1.05 = $95.24 Why? Because you could have invested $95.24 today, earned 5% interest over the course of the year, and have ended up with $100 at the end $95.24 x 0.05 = $4.76 $100
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Present Value: How to Compute Plot the cash flows out over the periods in which they will be obtained Divide the cash flows by (1 + discount rate), exponentiated by the number of compounding periods away For example, 3 periods away and 5% rate: denominator = 1.05 3 $100 / 1.05 2 Obtain $100 at the end of 2 periods; rate is 5% Receive $100 Today $90.70 Why does this work?
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Present Value: How to Compute It works because $90.70 would compound up to $100 if invested over 2 periods at 5% Today $90.70 $95.24 x 0.05 = $4.54 x 0.05 = $4.76 $100
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Net Present Value: How to Compute If we have multiple or repeated cash flows, we need to come up with a Net or summation of all the discounted cash amounts Plot all cash flows out over the periods in which they will be obtained Divide each cash flow by (1 + discount rate), exponentiated by the number of compounding periods away Sum the discounted amounts Obtain $100 at the end of each period over 2 years (total of $200); rate is 5% $100 / 1.05 2 Today $90.70 $100 / 1.05 $95.24 $185.94 Net Present Value of this series of cash flows
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Present Value of $1 Interest Rate 1 2 3 4 5 6 7 8 9 10 Periods (n) 1 0.9901 0.9804 0.9709 0.9615 0.9524 0.9434 0.9346 0.9259 0.9174 0.9091 2 0.9803 0.9612 0.9426 0.9246 0.9070 0.8900 0.8734 0.8573 0.8417 0.8264 3 0.9706 0.9423 0.9151 0.8890 0.8638 0.8396 0.8163 0.7938 0.7722 0.7513 4 0.9610 0.9238 0.8885 0.8548 0.8227 0.7921 0.7629 0.7350 0.7084 0.6830 5 0.9515 0.9057 0.8626 0.8219 0.7835 0.7473 0.7130 0.6806 0.6499 0.6209 6 0.9420 0.8880 0.8375 0.7903 0.7462 0.7050 0.6663 0.6302 0.5963 0.5645 7 0.9327 0.8706 0.8131 0.7599 0.7107 0.6651 0.6227
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This note was uploaded on 12/18/2010 for the course ACCT 101 taught by Professor Armstrong during the Fall '09 term at UPenn.

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Lecture16 2010.11.10 PostClass - Lecture 16 Accounting for...

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