# Financial Accounting (book part 2).docx - Appendix G Time...

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AppendixGTime Value of MoneyLearning ObjectivesAfter studying this appendix, you should be able to:Distinguish between simple and compound interest.Solve for future value of a single amount.Solve for future value of an annuity.Identify the variables fundamental to solving present value problems.Solve for present value of a single amount.Solve for present value of an annuity.Compute the present value of notes and bonds.Compute the present values in capital budgeting situations.Use a financial calculator to solve time value of money problems.Would you rather receive \$1,000 today or a year from now? You should prefer to receive the \$1,000 today because you can investthe \$1,000 and earn interest on it. As a result, you will have morethan \$1,000 a year from now. What this example illustrates is theconcept of the time value of money. Everyone prefers to receive money today rather than in the future because of the interest factor.1Distinguish between simple and compound interest.
specific period of time. The rate of interest is generally stated as an annual rate.The amount of interest involved in any financing transaction is based on three elements:1.1. Principal (p):The original amount borrowed or invested.2.2. Interest Rate (i):An annual percentage of the principal.3.3. Time (n):The number of years that the principal is borrowed or invested.Simple InterestSimple interestis computed on the principal amount only. It is the return on the principal for one period. Simple interest is usually expressed as shown in Illustration G-1.Illustration G-1Interest computationCompound InterestCompound interestis computed on principal andon any interest earned that has not been paid or withdrawn. It is the return on (or growth of) the principal for two or more time periods. Compounding computes interest not only on the principal but also on the interest earned to date on that principal, assuming the interest is left on deposit.To illustrate the difference between simple and compound interest, assume that you deposit \$1,000 in Bank Two, where it will earn simple interest of 9% per year, and you deposit another \$1,000 in Citizens Bank, where it will earn compound interest of 9% per year compounded annually. Also assume that in both cases you will not withdraw any cash until three years from the
date of deposit. Illustration G-2shows the computation of interestto be received and the accumulated year-end balances.Illustration G-2Simple versus compound interestNote in Illustration G-2that simple interest uses the initial principal of \$1,000 to compute the interest in all three years.
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