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Lecture16 2010.11.09 PreClass

# Lecture16 2010.11.09 PreClass - 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
Time Value of Money You are given the choice of \$1 today or \$1 a year from now. What do you prefer? Why? Simple interest 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 – i.e. amount expected to be received at some future date 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
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 The Present Value of an amount is always lower than the amount itself Why? Because waiting makes you forego consumption at today’s purchasing power or it makes you forego investment at your earning capacity

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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?
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
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 0.5835 0.5470 0.5132 8 0.9235 0.8535 0.7894 0.7307 0.6768 0.6274 0.5820 0.5403 0.5019 0.4665 9 0.9143 0.8368 0.7664 0.7026 0.6446 0.5919 0.5439 0.5002 0.4604 0.4241 10 0.9053 0.8203 0.7441 0.6756 0.6139 0.5584 0.5083 0.4632 0.4224 0.3855 11 0.8963 0.8043 0.7224 0.6496 0.5847 0.5268 0.4751 0.4289 0.3875 0.3505 12 0.8874 0.7885 0.7014 0.6246 0.5568 0.4970 0.4440 0.3971 0.3555 0.3186 13 0.8787 0.7730 0.6810 0.6006 0.5303 0.4688 0.4150 0.3677 0.3262 0.2897 14 0.8700 0.7579 0.6611 0.5775 0.5051 0.4423 0.3878 0.3405 0.2992 0.2633 15 0.8613 0.7430 0.6419 0.5553 0.4810 0.4173 0.3624 0.3152 0.2745 0.2394 16 0.8528 0.7284 0.6232 0.5339 0.4581 0.3936 0.3387 0.2919 0.2519 0.2176 17 0.8444 0.7142 0.6050 0.5134 0.4363 0.3714 0.3166 0.2703 0.2311 0.1978 18 0.8360 0.7002 0.5874 0.4936 0.4155 0.3503 0.2959 0.2502 0.2120 0.1799 19 0.8277 0.6864 0.5703 0.4746 0.3957 0.3305 0.2765 0.2317 0.1945 0.1635 20 0.8195 0.6730 0.5537 0.4564 0.3769 0.3118 0.2584 0.2145 0.1784

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Lecture16 2010.11.09 PreClass - Lecture 16 Accounting for...

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