Chap 006

Chapter 006 Time Value of Money Concepts

Chapter 006 Time Value of Money Concepts

True / False Questions

1. Compound interest includes interest earned on interest. TRUE

AACSB: Reflective thinkingBlooms: KnowledgeLearning Objective: 1Level of Learning: 12.When interest is compounded, the stated rate of interest exceeds the effective rate of interest.FALSE

AACSB: Reflective thinkingBlooms: KnowledgeLearning Objective: 1Level of Learning: 23.The calculation of future value requires the removal of interest.FALSE

AACSB: Reflective thinkingBlooms: KnowledgeLearning Objective: 2Level of Learning: 14.The company's credit-adjusted risk-free rate of interest is used when computing present value applying the expected cash flow approach.TRUE

AACSB: Reflective thinkingBlooms: KnowledgeLearning Objective: 3Level of Learning: 1

5.The calculation of present value eliminates interest from future cash flows.TRUE

AACSB: Reflective thinkingBlooms: KnowledgeLearning Objective: 3Level of Learning: 16.With an ordinary annuity, a payment is made or received on the date the agreement begins.FALSE

AACSB: Reflective thinkingBlooms: KnowledgeLearning Objective: 5Level of Learning: 17.In the future value of an ordinary annuity, the last cash payment will not earn any interest.TRUE

AACSB: Reflective thinkingBlooms: KnowledgeLearning Objective: 5Level of Learning: 18.An annuity consists of level principal payments plus interest on the unpaid balance.FALSE

AACSB: Reflective thinkingBlooms: KnowledgeLearning Objective: 5Level of Learning: 19.With an annuity due, a payment is made or received on the date the agreement begins.TRUE


10.An annuity is a series of equal periodic payments.TRUE

AACSB: Reflective thinkingBlooms: KnowledgeLearning Objective: 5Level of Learning: 111.Given identical current amounts owed and identical interest rates, annual payments of an ordinary annuity will be greater than annual payments of an annuity due.TRUE

AACSB: Reflective thinkingBlooms: ComprehensionLearning Objective: 5Level of Learning: 212.Other things being equal, the present value of an annuity due will be less than the present value of an ordinary annuity.FALSE

AACSB: Reflective thinkingBlooms: ComprehensionLearning Objective: 7Level of Learning: 213.A deferred annuity is one in which interest charges are deferred for a stated time period.FALSE


14.Monetary assets include only cash and cash equivalents.FALSE

AACSB: Reflective thinkingBlooms: KnowledgeLearning Objective: 9Level of Learning: 115.Most, but not all, liabilities are monetary liabilities.TRUE


Essay Questions

Listed below are ten terms followed by a list of phrases that describe or characterize five of the terms. Match each phrase with the correct term placing the letter designating the best term in the space provided by the phrase.

Terms:A. AnnuityB. Future valueC. Future value of an annuity dueD. Future value of an ordinary annuityE. Monetary assetF. Nonmonetary assetG. Present value of a single amountH. Present value of an annuity dueI. Simple interestJ. Time value of money

16._____ A dollar now is worth more than a dollar later.

J

AACSB: Reflective thinkingBlooms: Comprehension17._____ A series of equal periodic payments.

A

AACSB: Reflective thinkingBlooms: Comprehension

18._____ Accumulation of a series of equal payments with the last payment accruing interest.

C

AACSB: Reflective thinkingBlooms: Comprehension19._____ Accumulation of a series of equal payments with the last payment accruing no interest.

D

AACSB: Reflective thinkingBlooms: Comprehension20._____ Accumulation of an amount with interest.

B



Terms:A. AnnuityB. Future valueC. Future value of an annuity dueD. Future value of an ordinary annuityE. Monetary assetF. Nonmonetary assetG. Present value of a single amountH. Present value of an annuity dueI. Simple interestJ. Time value of money

21._____ Amount today equivalent to a specified future amount.

G

AACSB: Reflective thinkingBlooms: Comprehension22._____ Its amount is not fixed or determinable.

F

AACSB: Reflective thinkingBlooms: Comprehension23._____ Based on initial principal only.

I


24._____ Claim to a fixed amount of cash.

E

AACSB: Reflective thinkingBlooms: Comprehension25._____ Current worth of a series of equal payments received at the beginning of a period.

H

AACSB: Reflective thinkingBlooms: ComprehensionListed below are ten terms followed by a list of phrases that describe or characterize five of the terms. Match each phrase with the correct term placing the letter designating the best term in the space provided by the phrase.

Terms:A. Annuity dueB. Compound interestC. Deferred annuityD. Effective yieldE. Future value of a single amountF. InterestG. Monetary liabilityH. Ordinary annuityI. Present valueJ. Present value of an ordinary annuity

26._____ Current worth of a series of equal payments received at the end of a period.

J


27._____ Current worth of future cash flow(s).

I

AACSB: Reflective thinkingBlooms: Comprehension28._____ Fixed obligation to pay an amount in cash.

G

AACSB: Reflective thinkingBlooms: Comprehension29._____ Interest accumulates on interest.

B

AACSB: Reflective thinkingBlooms: Comprehension30._____The rate at which money will actually grow.

D



Terms:A. Annuity dueB. Compound interestC. Deferred annuityD. Effective yieldE. Future value of a single amountF. InterestG. Monetary liabilityH. Ordinary annuityI. Present valueJ. Present value of an ordinary annuity

31._____ Rent for the use of money.

F

AACSB: Reflective thinkingBlooms: Comprehension32._____ Series of equal cash payments received at the beginning of each period.

A

AACSB: Reflective thinkingBlooms: Comprehension33._____ Series of equal cash payments received at the end of each period.

H


34._____ Series of equal cash payments with the first cash payment more than one period after the contract date.

C

AACSB: Reflective thinkingBlooms: Comprehension35._____ The money to which an amount invested will grow with time.

E

AACSB: Reflective thinkingBlooms: ComprehensionListed below are columns of time value of money tables for the 9% rate, followed by labels for FIVE of the columns. Match the columns with their appropriate labels by placing the letter designating the column in the space provided by the label.

36._____ Present value of an annuity due of $1

C


37._____ Future value of an annuity due of $1

F

AACSB: Reflective thinkingBlooms: Comprehension38._____ Present value of $1

D

AACSB: Reflective thinkingBlooms: Comprehension39._____ Future value of $1

A

AACSB: Reflective thinkingBlooms: Comprehension40._____ Present value of an ordinary annuity of $1

B


Listed below are ten terms followed by a list of phrases that describe or characterize the terms. Match each phrase with the correct term placing the letter designating the best term in the space provided by the phrase.

Terms:A. AnnuityB. InterestC. Future value of an annuity dueD. Present value of an ordinary annuityE. Monetary assetF. Future value of a single amountG. Present value of a single amountH. Annuity dueI. Deferred annuityJ. Expected cash flow approachPhrases:

41._____ Amount of money required today that is equivalent to a given future amount.

G

AACSB: Reflective thinkingBlooms: Comprehension42._____ The amount of money that a dollar will grow to.

F

AACSB: Reflective thinkingBlooms: Comprehension43._____ First cash flow occurs on the first day of the agreement.

H


44._____ Claim to a fixed amount of cash.

E

AACSB: Reflective thinkingBlooms: Comprehension45._____ Present value of equal-sized cash flows beginning at the end of the period.

D

AACSB: Reflective thinkingBlooms: Comprehension46._____ The first cash flow occurs more than one period after the date of the agreement.

I

AACSB: Reflective thinkingBlooms: Comprehension47._____ Discount rate is the credit-adjusted risk-free rate.

J

AACSB: Reflective thinkingBlooms: Comprehension48._____ A series of equal-sized cash flows.

A


49._____ Future value of equal-sized cash flows starting at the beginning of the period.

C

AACSB: Reflective thinkingBlooms: Comprehension50._____ Amount of money paid/received in excess of the amount borrowed/lent.

B


Multiple Choice Questions

Present and future value tables of $1 at 3% are presented below:

51.Today Thomas deposited $100,000 in a three-year, 12% CD that compounds quarterly. What is the maturity value of the CD?A.$109,270.B.$119,410.C.$142,576.D.$309,090.

FV = $100,000 x 1.42576* = $142,576*FV of $1: n = 12; i = 3%

AACSB: AnalyticBlooms: ApplicationLearning Objective: 1Level of Learning: 3

52.Carol wants to invest money in a 6% CD account that compounds semiannually. Carol would like the account to have a balance of $50,000 five years from now. How much must Carol deposit to accomplish her goal?A.$35,069.B.$43,131.C.$37,205.D.$35,000.

PV = $50,000 x .744409* = $37,205*PV of $1: n=10; i=3%

AACSB: AnalyticBlooms: ApplicationLearning Objective: 3Level of Learning: 353.Shane wants to invest money in a 6% CD account that compounds semiannually. Shane would like the account to have a balance of $100,000 four years from now. How much must Shane deposit to accomplish his goal?A.$88,848.B.$78,941.C.$25,336.D.$22,510.

PV = $100,000 x .78941* = $78,941*PV of $1: n=8; i=3%


54.Bill wants to give Maria a $500,000 gift in seven years. If money is worth 6% compounded semiannually, what is Maria's gift worth today?A.$ 66,110.B.$ 81,310.C.$406,550.D.$330,560.

PV = $500,000 x .66112* = $330,560*PV of $1: n=14; i=3%

AACSB: AnalyticBlooms: ApplicationLearning Objective: 3Level of Learning: 355.Monica wants to sell her share of an investment to Barney for $50,000 in three years. If money is worth 6% compounded semiannually, what would Monica accept today?A.$ 8,375.B.$41,874.C.$11,941.D.$41,000.

PV = $50,000 x .83748* = $41,874*PV of $1: n=6; i=3%


56.At the end of the next four years, a new machine is expected to generate net cash flows of $8,000, $12,000, $10,000, and $15,000, respectively. What are the cash flows worth today if a 3% interest rate properly reflects the time value of money in this situation?A.$41,556.B.$47,700.C.$32,400.D.$38,100.

($8,000 x .97087) + ($12,000 x .94260) + ($10,000 x .91514) + ($15,000 x .88849) = $7,767 + 11,311 + 9,151 + 13,327 = $41,556

AACSB: AnalyticBlooms: ApplicationLearning Objective: 3Level of Learning: 357.At the end of each quarter, Patti deposits $500 into an account that pays 12% interest compounded quarterly. How much will Patti have in the account in three years?A.$7,096.B.$7,013.C.$7,129.D.$8,880.

FVA = $500 x 14.1920* = $7,096*FVA of $1: n=12; i=3%


58.Sondra deposits $2,000 in an IRA account on April 15, 2009. Assume the account will earn 3% annually. If she repeats this for the next nine years, how much will she have on deposit on April 14, 2019?A.$20,600.B.$20,728.C.$23,616.D.$24,715.

FVAD = $2,000 x 11.8078* = $23,616*FVAD of $1: n=10; i=3%

AACSB: AnalyticBlooms: ApplicationLearning Objective: 6Level of Learning: 359.Shelley wants to cash in her winning lottery ticket. She can either receive ten, $100,000 semiannual payments starting today, or she can receive a lump-sum payment now based on a 6% annual interest rate. What is the equivalent lump-sum payment?A.$853,020.B.$801,971.C.$744,090.D.$878,611.

PVAD = $100,000 x 8.78611* = $878,611*PVAD of $1: n=10; i=3%


60.On January 1, 2009, you are considering making an investment that will pay three annual payments of $10,000. The first payment is not expected until December 31, 2011. You are eager to earn 3%. What is the present value of the investment on January 1, 2009?A.$26,662.B.$27,462.C.$28,286.D.$29,135.

PVA = $10,000 x ( 4.57971* - 1.91347**) = $26,662*PVA of $1: n=5; i=3% **PVA of $1: n=2; i=3%

AACSB: AnalyticBlooms: ApplicationLearning Objective: 7Level of Learning: 361.On January 1, 2009, you are considering making an investment that will pay three annual payments of $10,000. The first payment is not expected until December 31, 2012. You are eager to earn 3%. What is the present value of the investment on January 1, 2009?A.$28,286.B.$25,886.C.$26,662.D.$27,300.

PVA = $10,000 x (5.41719* - 2.82861**) = $25,886*PVA of $1: n=6; i=3% **PVA of $1: n=3; i=3%


62.Rosie's Florist borrows $300,000 to be paid off in six years. The loan payments are semiannual with the first payment due in six months, and interest is at 6%. What is the amount of each payment?A.$25,750.B.$29,761.C.$30,139.D.$25,500.

$300,000 9.95400* = $30,139*PVA of $1: n=12; i=3%

AACSB: AnalyticBlooms: ApplicationLearning Objective: 8Level of Learning: 363.Jimmy has $255,906 accumulated in a 401K plan. The fund is earning a low, but safe, 3% a year. The withdrawals will take place at the end of each year starting a year from now. How soon will the fund be exhausted if Jimmy withdraws $30,000 each year?A.11 years.B.10 years.C.8.5 years.D.8.8 years.

$255,906 $30,000 = 8.5302For PVA of $1 factor of 8.5302 and i of 3%, n = 10


64.Debbie has $368,882 accumulated in a 401K plan. The fund is earning a low, but safe, 3% a year. The withdrawals will take place annually starting today. How soon will the fund be exhausted if Debbie withdraws $30,000 each year?A.15 years.B.16 years.C.14 years.D.12.3 years.

$368,882 $30,000 = 12.29607For PVAD of $1 factor of 12.29607 and i of 3%, n = 15

AACSB: AnalyticBlooms: ApplicationLearning Objective: 8Level of Learning: 365.Jose wants to cash in his winning lottery ticket. He can either receive five, $5,000 semiannual payments starting today, or he can receive a lump-sum payment now based on a 6% annual interest rate. What would be the lump-sum payment?A.$23,586.B.$22,899.C.$21,565.D.$23,000.

PVAD = $ 5,000 x 4.71710* = $23,586*PVAD of $1: n=5; i=3%


66.Micro Brewery borrows $300,000 to be paid off in three years. The loan payments are semiannual with the first payment due in six months, and interest is at 6%. What is the amount of each payment?A.$ 55,379.B.$106,059.C.$ 30,138.D.$ 60,276.

$300,000 5.41719* = $55,379*PVA of $1: n=6; i=3%

AACSB: AnalyticBlooms: ApplicationLearning Objective: 8Level of Learning: 367.A firm leases equipment under a capital lease (analogous to an installment purchase) that calls for twelve semiannual payments of $39,014.40. The first payment is due at the inception of the lease. The annual rate on the lease is 6%. What is the value of the leased asset at inception of the lease?A.$388,349.B.$400,000.C.$454,128.D.$440,082.

PVAD = $39,014.40 x 10.25262 * = $400,000*PVAD of $1: n=12; i=3%


Below are excerpts from time value of money tables for the 8% rate.

68.Column 1 is an interest table for the:A.Present value of an ordinary annuity of 1.B.Future value of an ordinary annuity of 1.C.Present value of an annuity due of 1.D.Future value of an annuity due of 1.

AACSB: Reflective thinkingBlooms: ComprehensionLearning Objective: 7Level of Learning: 269.Column 2 is an interest table for the:A.Present value of an ordinary annuity of 1.B.Future value of an ordinary annuity of 1.C.Present value of an annuity due of 1.D.Future value of an annuity due of 1.

AACSB: Reflective thinkingBlooms: ComprehensionLearning Objective: 6Level of Learning: 2

70.Column 3 is an interest table for the:A.Present value of 1.B.Future value of 1.C.Present value of an ordinary annuity of 1.D.Present value of an annuity due of 1.

AACSB: Reflective thinkingBlooms: ComprehensionLearning Objective: 3Level of Learning: 271.Column 4 is an interest table for the:A.Present value of an ordinary annuity of 1.B.Future value of an ordinary annuity of 1.C.Present value of an annuity due of 1.D.Future value of an annuity due of 1.

AACSB: Reflective thinkingBlooms: ComprehensionLearning Objective: 6Level of Learning: 272.Column 5 is an interest table for the:A.Present value of 1.B.Future value of 1.C.Present value of an ordinary annuity of 1.D.Present value of an annuity due of 1.


73.Column 6 is an interest table for the:A.Present value of an ordinary annuity of 1.B.Future value of an ordinary annuity of 1.C.Present value of an annuity due of 1.D.Future value of an annuity due of 1.

AACSB: Reflective thinkingBlooms: ComprehensionLearning Objective: 7Level of Learning: 274.Reba wishes to know how much would be in her savings account if she deposits a given sum in an account and leaves it there at 6% interest for five years. She should use a table for the:A.Future value of an ordinary annuity of 1.B.Future value of 1.C.Future value of an annuity of 1.D.Present value of an annuity due of 1.


Present and future value tables of 1 at 9% are presented below.

75.Ajax Company purchased a five-year certificate of deposit for their building fund in the amount of $220,000. How much should the certificate of deposit be worth at the end of five years if interest is compounded at an annual rate of 9%?A.$857,230.B.$142,985.C.$319,000.D.$338,496.

FV = $220,000 x 1.53862* = $338,496*FV of $1: n=5; i=9%

AACSB: AnalyticBlooms: ApplicationLearning Objective: 2Level of Learning: 376.How much must be invested now at 9% interest to accumulate to $10,000 in five years?A.$9,176.B.$6,499.C.$5,500.D.$5,960.

PV = $10,000 x .64993* = $6,499*PV of $1: n=5; i=9%


77.How much must be deposited at the beginning of each year in order to accumulate to $10,000 in four years if interest is at 9%?A.$1,671.B.$2,570.C.$2,358.D.$2,006.

$10,000 4.9847* = $2,006*FVAD of $1: n=4; i=9%

AACSB: AnalyticBlooms: ApplicationLearning Objective: 6Level of Learning: 378.Claudine Corporation will deposit $5,000 into a money market sinking fund at the end of each year for the next five years. How much will accumulate by the end of the fifth and final payment if the sinking fund earns 9% interest?A.$32,617.B.$29,924.C.$27,250.D.$26,800.

FVA = $5,000 x 5.9847* = $29,924*FVA of $1: n=5; i=9%


79.Mustard's Inc. sold the rights to use one of their patented processes that will result in cash receipts of $2,500 at the end of each of the next four years and a lump sum receipt of $4,000 at the end of the fifth year. The total present value of these payments if interest is at 9% is:A.$10,699.B.$11,468.C.$12,100.D.$14,000.

AACSB: AnalyticBlooms: ApplicationLearning Objective: 7Level of Learning: 380.An investment product promises to pay $42,000 at the end of ten years. If an investor feels this investment should produce a rate of return of 12 percent, compounded annually, what's the most the investor should be willing to pay for the investment?A.$ 15,146.B.$ 13,523.C.$ 42,000.D.$130,446.

$42,000 x .32197* = $13,523 (rounded)*PV of $1: n=10; i=12%


81.LeAnn wishes to know how much she should set aside now at 7% interest in order to accumulate a sum of $5,000 in four years. She should use a table for the:A.Present value of 1.B.Future value of 1.C.Present value of an ordinary annuity of 1.D.Future value of an annuity due of 1.

AACSB: AnalyticBlooms: ApplicationLearning Objective: 3Level of Learning: 2Present and future value tables of 1 at 11% are presented below.

82.Spielberg Inc. signed a $200,000 noninterest-bearing note due in five years from a production company eager to do business. Comparable borrowings have carried an 11% interest rate. At what amount should this debt be valued at its inception?A.$200,000.B.$178,000.C.$118,690.D.$222,000.

PV = $200,000 x .59345* = $118,690*PV of $1: n=5; i=11%


83.On October 1, 2009, Justine Company purchased equipment from Napa Inc. in exchange for a noninterest-bearing note payable in five equal annual payments of $500,000, beginning Oct 1, 2010. Similar borrowings have carried an 11% interest rate. The equipment would be recorded at:A.$2,500,000.B.$2,225,000.C.$1,847,950.D.$2,115,270.

PVA = $500,000 x 3.69590* = $1,847,950*PVA of $1: n=5; i=11%

AACSB: AnalyticBlooms: ApplicationLearning Objective: 9Level of Learning: 384.Titanic Corporation leased executive limos under terms of $20,000 down and four equal annual payments of $30,000 on the anniversary date of the lease. The interest rate implicit in the lease is 11%. The first year's interest expense would be:A.$13,200.B.$10,238.C.$33,200.D.$15,543.

PVA = $30,000 x 3.10245* = $93,074$93,074 x 11% = $10,238*PVA of $1: n=4; i=11%


85.Polo Publishers purchased a multi-color offset press with terms of $50,000 down and a noninterest-bearing note requiring payment of $20,000 at the end of each year for five years. The interest rate implicit in the purchase contract is 11%. Polo would record the asset at:A.$109,618.B.$123,918.C.$130,000.D.$169,560.

$50,000 + ($20,000 x 3.69590) = $123,918*PVA of $1: n=5; i=11%

AACSB: AnalyticBlooms: ApplicationLearning Objective: 9Level of Learning: 386.Mary Alice just won the lottery and is trying to decide between the annual cash flow payment option of $250,000 per year for 25 years beginning today and the lump sum option. Mary Alice can earn 6 percent investing his money. At what lump-sum payment amount would she be indifferent between the two alternatives?A.$6,250,000.B.$3,195,840.C.$3,637,590.D.$3,387,590.

$250,000 x 13.55036* = $3,387,590*PVAD of $1: n=25; i=6%


87.An investor purchases a 20-year, $1,000 par value bond that pays semiannual interest of $40. If the semiannual market rate of interest is five percent, what is the current market value of the bond?A.$ 858.B.$1,686 .C.$1,000.D.$ 893.

*PVA of $1: n=40; i=5%**PV of $1: n=40; i=5%


88.Simpson Mining is obligated to restore leased land to its original condition after its excavation activities are over in three years. The cash flow possibilities and probabilities for the restoration costs in three years are as follows:

The company's credit-adjusted risk-free interest rate is 5%. The liability that Simpson must record at the beginning of the project for the restoration costs is:A.$ 129,576.B.$ 145,000.C.$ 125,257.D.$ 172,768.

*PV of $1: n=3; i=5%

AACSB: AnalyticBlooms: ApplicationLearning Objective: 4Level of Learning: 389.A series of equal periodic payments that starts more than one period after the agreement is called:A.An annuity due.B.An ordinary annuity.C.A future annuity.D.A deferred annuity.


90.A series of equal periodic payments in which the first payment is made one compounding period after the date of the contract is:A.A deferred annuity.B.An ordinary annuity.C.An annuity due.D.A delayed annuity.

AACSB: Reflective thinkingBlooms: KnowledgeLearning Objective: 5Level of Learning: 191.Loan A has the same original principal, interest rate, and payment amount as Loan B. However, Loan A is structured as an annuity due, while Loan B is structured as an ordinary annuity. The maturity date of Loan A will be:A.Earlier than Loan B.B.Later than Loan B.C.The same as Loan B.D.Indeterminate with respect to loan B.

AACSB: Reflective thinkingBlooms: ComprehensionLearning Objective: 5Level of Learning: 292.To determine the future value factor for an annuity due for period n when given tables only for an ordinary annuity:A.Obtain the FVA factor for n+1 and deduct 1.B.Obtain the FVA factor for n and deduct 1.C.Obtain the FVA factor for n-1 and add 1.D.Obtain the FVA factor for n+1 and add 1.


93.Yamaha Inc. hires a new chief financial officer and promises to pay him a lump sum bonus four years after he joins the company. The new CFO insists that the company invest an amount of money at the beginning of each year in a 7% fixed rate investment fund to insure the bonus will be available. To determine the amount that must be invested each year, a computation must be made using the formula for:A.The future value of a deferred annuity.B.The future value of an ordinary annuity.C.The future value of an annuity due.D.None of these is correct.

AACSB: Reflective thinkingBlooms: ComprehensionLearning Objective: 6Level of Learning: 294.Zulu Corporation hires a new chief executive officer and promises to pay her a signing bonus of $2 million per year for 10 years, starting five years after she joins the company. The liability for this bonus when the CEO is hired:A.Is the present value of a deferred annuity.B.Is the present value of an annuity due.C.Is $20 million.D.Is zero because no cash is owed for five years.

AACSB: Reflective thinkingBlooms: ComprehensionLearning Objective: 7Level of Learning: 295.Which of the following must be known to compute the interest rate paid from financing an asset purchase with an annuity?A.Fair value of the asset purchased, number and dollar amount of the annuity payments.B.Present value of the annuity, dollar amount and timing of the annuity payments.C.Fair value of the asset and timing of the annuity payments.D.Number of annuity payments and future value of the annuity.


96.Davenport Inc. offers a new employee a lump sum signing bonus at the date of employment. Alternatively, the employee can take $30,000 at the date of employment and another $50,000 two years later. Assuming the employee's time value of money is 8% annually, what lump sum at employment date would make her indifferent between the two options?A.$60,000.B.$62,867.C.$72,867.D.$80,000.

The lump sum equivalent would be $30,000 + the present value of $50,000 where n=2 and i=8%. That is, $30,000 + ($50,000 x 0.85734 from Table 2) = $72,867.

AACSB: AnalyticBlooms: ApplicationLearning Objective: 7Level of Learning: 397.Quaker State Inc. offers a new employee a lump sum signing bonus at the date of employment. Alternatively, the employee can take $8,000 at the date of employment plus $20,000 at the end of each of his first three years of service. Assuming the employee's time value of money is 10% annually, what lump sum at employment date would make him indifferent between the two options?A.$23,026.B.$57,737.C.$62,711.D.None of these is correct.

The lump sum equivalent would be $8,000 + the present value of a $20,000 ordinary annuity where n=3 and i=10%. That is, $8,000 + ($20,000 x 2.48685 from Table 4) = $57,737.


98.Garland Inc. offers a new employee a lump sum signing bonus at the date of employment, June 1, 2009. Alternatively, the employee can take $39,000 at the date of employment plus $10,000 each June 1 for five years, beginning in 2013. Assuming the employee's time value of money is 9% annually, what lump sum at employment date would make him indifferent between the two options?A.$44,035.B.$40,855.C.$69,035.D.$65,855.

The lump sum equivalent would be $39,000 + the present value of a $10,000 deferred annuity. The present value of the deferred annuity on June 1, 2010 is an annuity due with n=5 and i=9%. That is, ($10,000 x 4.23972 from Table 6) = $42,397. To compute the equivalent of that amount at employment date, we take the present value of $42,397 where n=4 and i=9% from Table 2, which is $42,397 x 0.70843 = $30,035. Therefore, the lump sum equivalent would be $39,000 + $30,035 = $69,035.

AACSB: AnalyticBlooms: ApplicationLearning Objective: 7Level of Learning: 399.On January 1, 2009, Glanville Company sold goods to Otter Corporation. Otter signed a noninterest-bearing note requiring payment of $15,000 annually for six years. The first payment was made on January 1, 2009. The prevailing rate of interest for this type of note at date of issuance was 8%.

Glanville should record the sales revenue in January 2009 of:A.$90,000.B.$69,343.C.$74,891.D.None of these.

$15,000 x 4.99271* = $74,891 (rounded)*PVAD of $1: n=6; i=8%


100.Loan C has the same principal amount, payment amount and maturity date as Loan D. However, Loan C is structured as an annuity due while Loan D is structured as an ordinary annuity. Loan C's interest rate is:A.Higher than Loan D.B.Less than Loan D.C.The same as Loan D.D.Indeterminate compared to Loan D.

AACSB: Reflective thinkingBlooms: ComprehensionLearning Objective: 8Level of Learning: 1101.Tammy wants to buy a car that costs $10,000 and wishes to know the amount of the monthly payments, which will be made at the first of the month, with interest of 12% on the unpaid balance. She should use a table for the:A.Present value of 1.B.Present value of an ordinary annuity of 1.C.Present value of an annuity due of 1.D.Future value of an annuity due of 1.

AACSB: Reflective thinkingBlooms: ComprehensionLearning Objective: 8Level of Learning: 2102.George Jones is planning on a cruise for his 70th birthday party. He wants to know how much he should set aside at the beginning of each month at 6% interest to accumulate the sum of $4,800 in five years. He should use a table for the:A.Future value of an ordinary annuity of 1.B.Future value of an annuity due of 1.C.Future value of 1.D.Present value of an annuity due of 1.


103.Sandra won $5,000,000 in the state lottery which she has elected to receive at the end of each month over the next thirty years. She will receive 7% interest on unpaid amounts. To determine the amount of her monthly check, she should use a table for the:A.Present value of an annuity of 1.B.Future value of an annuity due of 1.C.Present value of an ordinary annuity of 1.D.Future value of an ordinary annuity of 1.

AACSB: Reflective thinkingBlooms: ComprehensionLearning Objective: 8Level of Learning: 2104.First Financial Auto Loan Department wishes to know the payment required at the first of each month on a $10,500, 48-month, 11% auto loan. To determine this amount, First Financial would:A.Multiply $10,500 by the present value of 1.B.Divide $10,500 by the future value of an ordinary annuity of 1.C.Divide $10,500 by the present value of an annuity due of 1.D.Multiply $10,500 by the present value of an ordinary annuity of 1.

AACSB: Reflective thinkingBlooms: ApplicationLearning Objective: 8Level of Learning: 3105.Koko Company pays $10 million at the beginning of each year for 10 years to Mocha Inc. for a building with a fair value of $75 million. What interest rate is Mocha earning on financing this land sale?A.Between 13% and 14%.B.Between 7% and 8%.C.Between 5.5% and 6%.D.Cannot be determined from the given information.

That is, the present value of a 10-year annuity due of $10 million is $75 million, when the discount factor (from Table 6) equals 7.5000. That point is between 7% and 8% in the table.


106.Kunkle Company wishes to earn 20% annually on its investments. If it makes an investment that equals or exceeds that rate, it considers it a success. Assume that it invests $2 million and gets $500,000 in return at the end of each year fox X years. What is the minimum value of X for which it will consider the investment a success? Assume that it can't invest for fractional parts of a year.A.4 years.B.6 years.C.7 years.D.9 years.

The investment is successful when the present value of the ordinary annuity = $2 million. This is when the PV factor (from Table 4) is at least 4.0, so that multiplied by $500,000; it is at least $2 million. In Table 4, at i=20%, the factor passes the 4.0 level in year 9.

AACSB: AnalyticBlooms: AnalysisLearning Objective: 8Level of Learning: 3107.Chancellor Ltd. sells an asset with a $1 million fair value to Sophie Inc. Sophie agrees to make 6 equal payments, one year apart, commencing on the date of sale. The payments include principal and 6% annual interest. Compute the annual payments.A.$166,651.B.$135,252.C.$203,351.D.$191,852.

We compute the annual payments in the present value of an annuity due formula, where the present value is $1 million, n=6 and i=6%. The discount factor (from table 6) is 5.21236. Dividing $1 million by this factor gives payments of $191,852.


108.You borrow $20,000 to buy a boat. The loan is to be paid off in monthly installments over one year at 18 percent interest annually. The first payment is due one month from today. What is the amount of each monthly payment?A.$1,667.B.$1,511.C.$1,834.D.None of these.

$20,000 10.90751* = $1,834 (rounded)*PVA of $1: n=12; i=1.5%

AACSB: AnalyticBlooms: ApplicationLearning Objective: 8Level of Learning: 3109.Fenland Co. plans to retire $100 million in bonds in five years, so it wishes to create a fund by making equal investments at the beginning of each year during that period in an account it expects to earn 8% annually. What amount does Fenland need to invest each year?A.$15,783,077.B.$17,045,650.C.$23,190,400.D.Cannot be determined from the given information.

This is the amount in the future value of an annuity due formula, where $100 million = investment amount x factor from Table 5 where n=5 and i=8%. Thus, Investment amount = $100 million 6.3359 = $15,783,077.


Essay Questions

The following information was disclosed in the Debt footnote to the financial statements of Healdsburg Company for the year ended December 31, 2008: Debt. The following table summarizes the long-term debt of the Company at December 31, 2008. All of the notes were issued at their face (maturity) value. Required: Assuming that the notes pay interest annually and mature on December 31 of the respective years, compute the following:

110.The total cash interest payments in 2009 for these notes.

($201,335,000 x .0725) + ($345,154,000 x .0775) + ($225,000,000 x .08) + ($20 0,000,000 x .0763) + ($25,000,000 x .0655) = $76, 243,723

AACSB: AnalyticBlooms: ApplicationLearning Objective: 1Level of Learning: 3111.Suppose that Healdsburg wants to buy back the 7.75% notes on December 31, 2009 (i.e., 5 years early) when the going interest rate is 6%, thereby retiring the $345,154,000 in debt. How much would Healdsburg have to pay for the notes (principal only)?

Compute the PV of $345,154,000, where n = 5 and I = 6%. PV = $345,154,000 x .74726 = $257,919,778


112.Suppose that Healdsburg renegotiates the 8% notes on December 31, 2014 when the going interest rate is 8%. Healdsburg agrees to make 12 equal annual installments, commencing on December 31, 2015, rather than pay the $225 million in a lump sum at maturity. What would the annual payments be?

$225 million would be the PVA; n = 12 and I = 8%. Therefore, the payments would be $225 million 7.53608 = $29,856,371.

AACSB: AnalyticBlooms: ApplicationLearning Objective: 8Level of Learning: 3113.Suppose that Healdsburg enters into a sales contract with an auto manufacturer on January 1, 2009, to provide tires that cost Healdsburg $18 million to produce. The buyer offers Healdsburg $6 million in cash and agrees to take over the principal payment only on Healdsburg 's 6.55% debt notes. Assume that the going market interest is 7% at the time. What would Healdsburg's gross profit be on the sale?

The revenue would be $6 million + the PV of the 6.55% note principal, where n = 2 and I = 7%. Revenue = $6 million + ($25 million x .87344) = $27,836,000. Therefore, Healdsburg's gross profit on the sale would be $27,836,000 18,000,000 = $9,836,000.


114.Compute the future value of the following invested amounts at the specified periods and interest rates.

AACSB: AnalyticBlooms: ApplicationLearning Objective: 2Level of Learning: 2115.Compute the present value of the following single amounts to be received at the end of the specified period at the given interest rate.


116.DON Corp. is contemplating the purchase of a machine that will produce net after-tax cash savings of $20,000 per year for 5 years. At the end of five years, the machine can be sold to realize after-tax cash flows of $5,000. Interest is 12%. Assume the cash flows occur at the end of each year. Required: Calculate the total present value of the cash savings.

AACSB: AnalyticBlooms: ApplicationLearning Objective: 3Level of Learning: 3117.Touche Manufacturing is considering a rearrangement of its manufacturing operations. A consultant estimates that the rearrangement should result in after-tax cash savings of $6,000 the first year, $10,000 for the next two years, and $12,000 for the next two years. Interest is at 12%. Assume cash flows occur at the end of the year. Required: Calculate the total present value of the cash flows.


118.Price Mart is considering outsourcing its billing operations. A consultant estimates that outsourcing should result in after-tax cash savings of $9,000 the first year, $15,000 for the next two years, and $18,000 for the next two years. Interest is at 12%. Assume cash flows occur at the end of the year. Required: Calculate the total present value of the cash flows.

AACSB: AnalyticBlooms: ApplicationLearning Objective: 3Level of Learning: 3119.Baird Bros. Construction is considering the purchase of a machine at a cost of $125,000. The machine is expected to generate cash flows of $20,000 per year for ten years and can be sold at the end of ten years for $10,000. Interest is at 10%. Assume the machine would be paid for on the first day of year one, but that all other cash flows occur at the end of the year. Ignore income tax considerations. Required: Determine if Baird should purchase the machine.

Based on present value considerations, Baird Bros. Construction should buy the machine.

AACSB: AnalyticBlooms: AnalysisLearning Objective: 3Level of Learning: 3

120.Dobson Contractors is considering buying equipment at a cost of $75,000. The equipment is expected to generate cash flows of $15,000 per year for eight years and can be sold at the end of eight years for $5,000. Interest is at 12%. Assume the equipment would be paid for on the first day of year one, but that all other cash flows occur at the end of the year. Ignore income tax considerations. Required: Determine if Dobson should purchase the machine.

Based on present value considerations, Dobson Construction should buy the machine.


121.Hillsdale is considering two options for comparable computer software. Option A will cost $25,000 plus annual license renewals of $1,000 for three years, which includes technical support. Option B will cost $20,000 with technical support being an add-on charge. The estimated cost of technical support is $4,000 the first year, $3,000 the second year, and $2,000 the third year. Assume the software is purchased and paid for at the beginning of year one, but that technical support is paid for at the end of each year. Interest is at 8%. Ignore income taxes. Required: Determine which option should be chosen based on present value considerations.

Option A should be chosen because it has the lower cost based on present value considerations.


122.Bison Mfg. is considering two options for purchasing comparable machinery. Machine 1 will cost $27,500 plus an annual maintenance fee of $1,500 per year for four years. Machine 2 will cost $25,000 with maintenance being an add-on charge. The estimated cost of maintenance is $1,000 the first year, $3,000 the second year, and $4,000 the third year and the fourth year. Assume the purchase cost is paid up front, but that maintenance is paid for at the end of each year. Interest is at 10%. Ignore income taxes and residual values. Required: Determine which machine should be chosen based on present value considerations.

Option A should be chosen because it has the lower cost based on present value considerations.


123.On May 1, 2009, Bo Smith, proud father of newborn son Bobo, purchased $200,000 in zero-coupon bonds that mature on May 1, 2029. The bonds pay no interest during the period of time they are outstanding. The interest rate for such borrowings is at 9%. Interest compounds annually. Required: Calculate the price Bo paid for the bonds.

$200,000 x .17843* = $35,686*PV of $1: n=20; i=9%

AACSB: AnalyticBlooms: ApplicationLearning Objective: 3Level of Learning: 3124.On February 1, 2009, Lynda Brown, proud mother of newborn daughter Goldie, purchased $600,000 in zero-coupon bonds that mature on February 1, 2029. The bonds pay no interest during the period of time they are outstanding. The interest rate for such borrowings is at 12%. Required: Calculate the price Lynda paid for the bonds.

$600,000 x .10367* = $62,202*PV of $1: n=20; i=12%


125. On the last day of its fiscal year ending December 31, 2009, the Boatright Ship Builders completed two financing arrangements. The funds provided by these initiatives will allow the company to expand its operations. 1. Boatright issued 6% stated rate bonds with a face amount of $200 million. The bonds mature on December 31, 2029 (20 years). The market rate of interest for similar bond issues was 8% (4% semiannual rate). Interest is paid semiannually (3%) on June 30 and December 31, beginning on June 30, 2010. 2. The company leased two manufacturing facilities. Lease A requires 10 annual lease payments of $50,000 beginning on January 1, 2010. Lease B also is for 10 years, beginning January 1, 2010. Terms of the lease require 7 annual lease payments of $60,000 beginning on January 1, 2013. Accounting standards require both leases to be recorded as liabilities for the present value of the scheduled payments. Assume that an 8% interest rate properly reflects the time value of money for the lease obligations. Required: What amounts will appear in Boatright's December 31, 2009, balance sheet for the bonds and for the leases?

Bond liability: PV = $6,000,0001 (19.79277*) + 200,000,000 (.20829**) PV = $118,756,620 + 41,658,000 = $160,414,620 = initial bond liability 1 $200,000,000 x 3% = $6,000,000 *Present value of an ordinary annuity of $1: n=40, i=4% (from Table 4) **Present value of $1: n=40, i=4% (from Table 2) Lease liability: Lease A: PVAD = $50,000 (7.24689*) = $362,345 = Liability *Present value of an annuity due of $1: n=10, i=8% (from Table 6) Lease B: PVAD = $60,000 x 5.62288* = $337,373 *Present value of an annuity due of $1: n=7, i=8% (from Table 6) PV = $337,373 x .79383** = $267,817 **Present value of $1: n=3, i=8% (from Table 2) Or, alternatively for Lease B: PVA = $60,000 x 5.20637* = $312,382 *Present value of an ordinary annuity of $1: n=7, i=8% (from Table 4) PV = $312,382 x .85734** = $267,818 (difference due to rounding) **Present value of $1: n=2, i=8% (from Table 2) Or, alternatively for Lease B: PV = $60,000 (4.46363*) = $267,818 (difference due to rounding) From Table 4, The company's balance sheet would include a liability for bonds of $160,414,620 and a liability for leases of $630,162 ($362,345 +267,817).

AACSB: AnalyticBlooms: ApplicationLearning Objective: 3Learning Objective: 7Learning Objective: 9Level of Learning: 3

126. White & Decker Corporation's 2009 financial statements included the following information in the long-term debt disclosure note: The disclosure note stated that the debenture bonds were issued late in 2004 and have a maturity value of $500 million. The maturity value indicates the amount that White & Decker will pay bondholders in 2024. Each individual bond has a maturity value (face amount) of $1,000. Zero-coupon bonds pay no cash interest during the term to maturity. The company is "accreting" (gradually increasing) the issue price to maturity value using the bonds' effective interest rate computed on an annual basis. Required: 1. Determine the effective interest rate on the bonds. 2. Determine the issue price in late 2004 of a single, $1,000 maturity-value bond.

1. The effective interest rate can be determined by solving for the unknown present value of $1 factor for 15 annual periods (2009-2024): *Present value of $1: n = 15, i = ? (from Table 2, i = approximately 4%) In row 15 of Table 2, the value .55526 is in the 4% column. So, 4% is the approximate effective semiannual interest rate. A financial calculator or Excel will produce the same rate. 2. Using a 4% effective annual rate and 20 periods: PV = $1,000 (.45639*) = $456.39 *Present value of $1: n = 20, i = 4% (from Table 2) The issue price of one, $1,000 maturity-value bond was $456.39.

AACSB: AnalyticBlooms: ApplicationLearning Objective: 3Learning Objective: 9Level of Learning: 3

127.Santa Cruz Oil is obligated to the State of Nevada to restore leased land to its original condition after its oil drilling activities are over in four years. The cash flow possibilities are probabilities for the restoration costs in four years are as follows:

The company's credit-adjusted risk-free interest rate is 6%.

Required:Calculate the liability that Santa Cruz must record at the beginning of the project for the restoration costs.

Liability = $33,000,000 x .79209* = $26,138,970*PV of $1: n=4; i=6%


128.Jackpot Mining is obligated to the State of California to restore leased land to its original condition after its mining activities are over in six years. The cash flow possibilities and probabilities for the restoration costs in six years are as follows:

The company's credit-adjusted risk-free interest rate is 4%.

Required:Calculate the liability that Jackpot must record at the beginning of the project for the restoration costs.

Liability = $11,300,000 x .79031* = $8,930,503*PV of $1: n=6; i=4%

AACSB: AnalyticBlooms: ApplicationLearning Objective: 4Level of Learning: 3129.Incognito Company is contemplating the purchase of a machine that provides it with net after-tax cash savings of $80,000 per year for 5 years. Interest is 8%. Assume the cash savings occur at the end of each year. Required: Calculate the present value of the cash savings.

PVA = $80,000 x 3.99271 = $319,417


130.Samson Inc. is contemplating the purchase of a machine that will provide it with net after-tax cash savings of $100,000 per year for 8 years. Interest is 10%. Assume the cash savings occur at the end of each year. Required: Calculate the present value of the cash savings.

PVA = $100,000 x 5.33493 = $533,493


131.Under the MLB deferred compensation plan, payments made at the end of each year accumulate up to retirement and then retirees are given two options. Option 1 allows the retiree to select the amount of the annual payment to be received and option 2 allows the retiree to specify over how many years payments are to be received. Assume Sosa has had $5,000 deposited at the end of each year for 40 years, and that the long-term interest rate has been 7%. Required:a. How much has accumulated in Sosa's deferred compensation account?b. How much will Sosa be able to withdraw at the beginning of each year if he elects to receive payments for twenty years?c. For how many years will Sosa be able to receive payments if he chooses to receive $115,000 per year at the beginning of each year?

a. Balance in fund = FVA = $5,000 x 199.6351 = $998,176b. Option 2: $998,176 11.33560* = $88,057*PVAD of $1: n=20; i=7%c. Option 1: $998,176 $115,000 = 8.67979

.18112 .44402 = .41So Sosa will be able to receive payments of $115,000 for 12 years, with a partial payment in year 13 of approximately $115,000 x 41% = $47,150.


132.Under the NBA deferred compensation plan, payments made at the end of each year accumulate up to retirement and then retirees are given two options. Option 1 allows the retiree to select the amount of the annual payment to be received and option 2 allows the retiree to specify over how many years payments are to be received. Assume Rodman has had $6,000 deposited at the end of each year for 30 years, and that the long-term interest rate has been 8%. Required:a. How much has accumulated in Rodman's deferred compensation account?b. How much will Rodman be able to withdraw at the beginning of each year if he elects to receive payments for fifteen years?c. How many years will Rodman be able to receive payments if he chooses to receive $65,000 per year at the beginning of each year?

a. Balance in fund = FVA = $6,000 x 113.2832 = $679,699b. Option 2: $679,699 9.24424* = $73,527*PVAD of $1: n=15; i=8%c. Option 1: $679,699 $65,000 = 10.45691

.08502 .23171 = .37So Rodman will be able to receive $65,000 per year for 19 years, with a partial payment in year 20 of approximately $65,000 x 37% = $24,050.


133.ABC Company will issue $5,000,000 in 6%, 10-year bonds when the market rate of interest is 8%. Interest is paid semiannually. Required: Determine how much cash ABC Company will realize from the bond issue.

$5,000,000 x 3% = $150,000n= 20; i = 4%

AACSB: AnalyticBlooms: ApplicationLearning Objective: 9Level of Learning: 3134.DEF Company will issue $2,000,000 in 10%, 10-year bonds when the market rate of interest is 12%. Interest is paid semiannually. Required: Determine how much cash DEF Company should realize from the bond issue.

$2,000,000 x 5% = $100,000n= 20; i = 6%


135.GHI Company will issue $2,000,000 in 8%, 10-year bonds when the market rate of interest is 6%. Interest is paid semiannually. Required: Determine how much cash GHI Company should realize from the bond issue.

$2,000,000 x 4% = $80,000n= 20; i = 3%

AACSB: AnalyticBlooms: ApplicationLearning Objective: 9Level of Learning: 3136.JKL Company will issue $2,000,000 in 12%, 10 year bonds when the market rate of interest is 10%. Interest is paid semiannually. Required: Determine how much cash JKL Company should realize from the bond issue.

$2,000,000 x 6% = $120,000n= 20; i = 5%


137.MBI Company's largest computer has a cash selling price of $200,000. A customer wishes to buy the computer on a lease purchase plan over five years, with the first payment to be made at the inception of the lease. Interest is at 10%. Required:a. Compute the amount of the annual lease payment and the gross amount due (total payments) under the lease.b. Compute the amount of interest income earned by MBI for the first year of the lease.


138.Taylor's tractor-trailer rigs sell for $150,000. A customer wishes to buy a rig on a lease purchase plan over seven years, with the first payment to be made at the inception of the lease. Interest is at 12%. Required:a. Compute the amount of the annual lease payment and the gross amount (total payments) due under the lease.b. Compute the amount of interest income earned by Taylor's for the first year of the lease.


139.Titan Corporation has a defined benefit pension plan. One of its employees has vested benefits under the plan which will pay her $30,000 annually for life starting with the first $30,000 payment on the day she retires at the age of 65. The employee has just reached the age of 45. Titan consulted standard mortality tables to come up with a life expectancy of 80 for this employee. The implicit interest rate under the plan is 9%. Required:a. What will be the present value of the pension obligation at the time of the employee's retirement?b. What is the present value of the pension obligation at the current time?

a. 30,000 x 8.78615* = $263,585

*PVAD of $1: n=15; i= 9%

b. 263,585 x .17843** = $47,031

**PV of $1: n=20; i=9%


140.King Corporation has a defined benefit pension plan. One of its employees has vested benefits under the plan which will pay him $40,000 annually for life starting with the first payment of $40,000 on the day he retires at the age of 65. The employee has just reached the age of 50. King consulted standard mortality tables to come up with a life expectancy of 80 for this employee. The implicit interest rate under the plan is 9%. Required:a. What will be the present value of the pension obligation at the time of the employee's retirement?b. What is the present value of the pension obligation at the current time?

a. $40,000 x 8.78615* = $351,446

*PVAD of $1: n=15; i=9%

$351,446 x .27454** = $96,486

**PV of $1: n=15; i=9%

AACSB: AnalyticBlooms: ApplicationLearning Objective: 9Level of Learning: 3141.Briefly describe the difference between simple interest and compound interest.

Simple interest is computed only on the initial principal amount. Compound interest includes not only interest on the initial principal, but also interest on the accumulated interest to date.


142.Explain how you would compute the imputed interest on cash borrowed at zero percent interest when the market rate of interest is eight percent.

Imputed interest on a zero percent interest loan is a two-step process. First, compute the present value of the loan repayments by discounting at the appropriate market rate, 8% in this situation. Second, compare the loan amount to the lower present value computed in step one; the difference is the amount of imputed interest to be recognized over the term of the loan.


The following footnote disclosure is taken from the 2009 Annual Report to Shareholders of Eastern Oil Company. [Note that capital leases are ones like an installment purchase that require the lessor to record both a leased asset and a lease liability. By contrast, operating leases are treated purely as a rental.] 11. Leases (in $millions) Future minimum commitments for capital leases (including sale-leasebacks accounted for as financings) and for operating leases having remaining non-cancelable lease terms in excess of one year are as follows: Required:

143.What would happen if Eastern imputed an interest rate larger than the one used in this disclosure?

It would impute an amount of interest greater than the $47 million. Therefore, the remaining debt component of the payments (the obligation reported on the balance sheet) would be proportionally less than the $91 million reported.

AACSB: AnalyticBlooms: SynthesisLearning Objective: 4Level of Learning: 2

144.Describe how present value methods affect Eastern's long-term lease debt.

Eastern has long-term obligations on its capital leases. Those lease payments do not explicitly identify principal and interest, but the substance of these transactions is the same as other long-term debt. Therefore, the future payments disclosed must be discounted by an imputed interest rate (the going market rate for such transactions). In this case, the interest component is $47 million out of the $138 million to be paid. The rest ($91 million) is the present value of the debt, the amount that should be considered in the long-term liability section of Eastern's balance sheet.

AACSB: Reflective thinkingBlooms: ComprehensionLearning Objective: 9Level of Learning: 3145.How would the amount of Eastern's long-term lease debt be different if no interest was imputed?

All of the lease payments would be considered principal; thus, the debt would be reported as $138 million, rather than $91 million. This would also eliminate interest expense from these payments, thereby increasing earnings. This is not reflective of the underlying economic substance of the capital leases and is not permitted by GAAP.

AACSB: AnalyticBlooms: ComprehensionLearning Objective: 9Level of Learning:3146.Two banks each have annual CD rates of twelve percent. Bank A compounds quarterly and Bank B compounds semiannually. Explain which bank offers the better CD.

The yield on a CD increases with more frequent compounding periods. Therefore, since both CDs have the same stated rate of 12%, Bank A, that compounds quarterly, offers a better yield than Bank B with semiannual compounding.


147.Briefly describe the differences between an ordinary annuity, an annuity due, and a deferred annuity.

An annuity is a series of equal cash flows occurring over equal periods of time. In an ordinary annuity, cash flows occur at the end of each period; in an annuity due, cash flows occur at the beginning of each period; and in a deferred annuity, cash flows begin more than one period beyond the date of the agreement.

AACSB: Reflective thinkingBlooms: ComprehensionLearning Objective: 5Level of Learning: 2148.Prepare a time diagram for the future value an ordinary annuity with three payments of $300. Be sure to indicate the periods in which interest is added.


149.Prepare a time diagram for the future value an annuity due with three payments of $400. Be sure to indicate the periods in which interest is added.

AACSB: Reflective thinkingBlooms: KnowledgeLearning Objective: 6Level of Learning: 2150.Briefly explain how you would arrive at the monthly payment for a 48-month loan where the first payment is due one month from the loan date. In your explanation, include the use of present and future value tables.

The 48-month loan described is an ordinary annuity. Therefore, the appropriate table would be for the present value of an ordinary annuity (PVA). The annual stated interest rate would be divided by 12 to arrive at the periodic rate. Thus, an 18% annual rate yields a periodic rate of 1.5%. You would arrive at the monthly payment by dividing the known loan amount by the PVA factor at 1.5% for 48 periods.


151.Provide two examples of the use of present value techniques in accounting.

This question only asks for two examples of the use of present value techniques in accounting. The chapter previews the use of PV techniques in accounting for long-term leases and in computing the pension obligation for defined benefit plans. The major emphasis in the chapter is accounting for interest-bearing obligations, such as determining the selling price of bonds, solving for the payment on an installment loan, and determining both future and present value amounts.

AACSB: Reflective thinkingBlooms: SynthesisLearning Objective: 9Level of Learning: 26-1

Chap 006

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