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Chapter 11 - Solution Manual

In these circumstances the notes present value is

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funds. In these circumstances the note's present value is identical with its face value. Furthermore, where the rate of interest is reasonable and separately stated, the face value of the note is equal to the bargained exchange price for the property. ii. When a note bears no interest (or has a stated interest rate that differs sharply from the prevailing rate) and/or is not issued in an arm's-length transaction, the present value must be determined through consideration of the economic substance of the transaction. The note and the sales price of the property, goods or services exchanged for the note should be recorded at the fair value of the property, goods, or services or at an amount that reasonably approximates the market value of the note, whichever is the more clearly determinable. That amount may or may not be the same as the face amount; any resulting discount or premium should be accounted for as an element of interest over the life of the note. In the absence of established exchange prices for the related property, goods or services or evidence of the market value of the note, the present value of a note that stipulates no interest (or a rate of interest that differs sharply from the prevailing rate) should be determined by discounting all future payments on the note, using an imputed rate of interest as described below. This determination should be made at the time the note is issued; any subsequent changes in prevailing interest rates should be ignored.
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221 The variety of transactions encountered precludes any specific interest rate from being applicable in all circumstances. However, some general guides may be stated. The choice of a rate may be affected by the credit standing of the issuer, restrictive covenants, the collateral, payment, other terms pertaining to the debt, and the tax consequences to the buyer and seller. The prevailing rates for similar instruments of issuers with similar credit ratings will normally help determine the appropriate interest rate. In any event, the rate used for valuation purposes will normally be at least equal to the rate at which the debtor can obtain financing of a similar nature from other sources at the date of the transaction. The objective is to approximate the rate that would have resulted if an independent borrower and an independent lender had negotiated a similar transaction under comparable terms and conditions with the option to pay the cash price upon purchase or to give a note for the amount of the purchase that bears the prevailing rate of interest to maturity. b.i. If the recorded value of a note differs from its face value, the difference should be treated as discount or premium and amortized as interest over the life of the note in such a way as to result in a constant rate of interest when applied to the amount outstanding at the beginning of any given period. This is the "interest" method. Other methods of amortization may be used if the
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