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Unformatted text preview: 1 Chapter 6 Accounting and the Time Value of Money 2 Accounting and the Time Value of Money Future value of a single sum Present value of a single sum Solving for other unknowns Basic Time Value Concepts SingleSum Problems Annuities More Complex Situations Present Value Measurement Applications The nature of interest Simple interest Compound interest Fundamental variables Future value of ordinary annuity Future value of annuity due Examples of FV of annuity Present value of ordinary annuity Present value of annuity due Examples of PV of annuity Deferred annuities Valuation of longterm bonds Effective interest method of bond discount/ premium amortization Expected cash flow illustration 3 Basic Time Value Concept You have two options to choose. Which one do you prefer? Why? Option 1: Receive $1 million today Option 2: Receive $1 million 1 year later A dollar received today is worth more than a dollar promised at some time in the future. Because of the investment opportunity 4 Applications of Time Value Concepts The FASB increasingly is requiring the use of fair values in the measurement of assets and liabilities. The most useful fair value measures are based on prices established on active markets. However, for many assets and liabilities, marketbased fair values are not available. Fair value can be estimated based on the expected cash flows. These cash flows can be converted into present values. 5 Nature of Interest Interest Payment for the use of money Excess cash received or repaid over and above the amount lent or borrowed (principal) Example: you borrow $10,000 for one year, and repay $11,500 Rate of interest: 1,500 / 10,000 = 15% Variables in Interest Computation Principal: the amount borrowed or invested Interest Rate: A percentage of the outstanding principal Time: the number of years that the principal is outstanding 6 Simple Interest Interest computed on the principal only ILLUSTRATION: On January 2, 2007, 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 FULL YEAR FULL YEAR 7 Simple Interest (Cont) ILLUSTRATION continued: On March 31, 2007, Tomalczyk borrows $20,000 for 3 years at a rate of 7% per year. Calculate the interest cost for the year ending December 31, 2007. Principal $20,000 Interest rate x 7% Annual interest $ 1,400 Partial year x 9/12 Interest for 9 months PARTIAL PARTIAL YEAR YEAR 8 Compound Interest 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. 9 Compound Interest (Cont) ILLUSTRATION: On January 2, 2007, Tomalczyk borrows $20,000 for 3 years at a rate of 7% per year. Calculate the total interest cost for all three years, assuming interest is compounded annually....
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 Spring '08
 CMEasterwood
 Accounting, Time Value Of Money, Future Value, Net Present Value

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