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Illustration 1: Long Term Notes PayableIllustration 1: Long Term Notes Payable

May be interest bearing or non-interest bearing (we will look at non-interest bearing).

May be serial notes (periodic payments) or term notes (balloon payments). We will look at balloon payments here (serial payments, or annuities, later).

Illustration 1: On January, 2, 2008, Pearson Company purchases a section of land for its new plant site. Pearson issues a 5 year non-interest bearing note, and promises to pay $50,000 at the end of the 5 year period. What is the cash equivalent price of the land, if a 6 percent discount rate is assumed?

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Illustration1 SolutionIllustration1 Solution

See page 370, Table 9-2

PV1 Table

PV1 = FV1( ) i, n PV1 Table

i=6%, n=5 Journal entry Jan. 2, 2008:

Land 37,350Discount on N/P12,650

Notes Payable 50,000

PV1 = 50,000 ( 0.747) = $37,350

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Illustration1 Solution, continuedIllustration1 Solution, continuedJournal entry, December 31, 2008, assuming

Pearson uses the straight-line method to recognize interest expense (12,650 / 5):

Carrying value on B/S at 12/31/2008?

Carrying value on B/S at 12/31/2012?

Interest expense 2,530Discount on N/P 2,530

Notes Payable $50,000Discount on N/P (10,120) $39,880

(Discount = 12,650 - 2,530 = 10,120)

50,000 - 0 = 50,000

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Illustration 2: InvestmentIllustration 2: Investment

Holliman Company wants to accumulate $500,000 at the end of 10 years. What amount must it invest today to achieve that balance, assuming a 6% interest rate, compounded annually?

PV1 Table

PV1 = ( ) = i=6%, n=10

What if the interest is compounded semiannually?

PV1 Table

PV1 = ( ) =

500,000 0.558 $279,000

n = 10 x 2 = 20 periods, i = 6% / 2 = 3% per period

500,000 0.554i=3%, n=20

$277,000

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Illustration 3: Long Term Notes PayableIllustration 3: Long Term Notes Payable

Illustration 3: On January, 2, 2008, Pearson Company purchases a section of land for its new plant site. Pearson issues a 5 year non-interest bearing note, and promises to pay $10,000 per year at the end of each of the next 5 years. What is the cash equivalent price of the land, if a 6 percent discount rate is assumed?

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Illustration 3 SolutionIllustration 3 Solution

See page 372, Table 9-4

PVA Table

PVA = A ( ) i, n PVA Table

i=6%, n=5 Journal entry Jan. 2, 2008:

Land 42,120Discount on N/P 7,880

Notes Payable 50,000

PVA = 10,000 ( 4.212) = $42,120

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Illustration 4: Annuity IncomeIllustration 4: Annuity Income

Illustration 4: On January, 2, 2008, Donna Smith won the lottery. She was offered an annuity of $100,000 per year for the next 20 years, or $1,000,000 today as an alternative settlement. Which option should Donna choose. Assume that she can earn an average 4 percent return on her investments for the next 20 years.

Solution: calculate the present value of the annuity at a discount rate of 4%.

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Illustration 4 SolutionIllustration 4 Solution

See page 372, Table 9-4

PVA Table

PVA = A ( ) i, n PVA Table

i=4%, n=20 Which should she choose?

At approximately what interest (discount) rate would she choose differently? (Based on whole percentage rate)

Choose the annuity, PV > $1,000,000

PVA = 100,000 (13.590) = $1,359,000

At 8 % interest, PV < $1,000,000

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Illustration 5: InvestmentIllustration 5: Investment

Holliman Company wants to invest $200,000 cash it received from the sale of land. What amount will it accumulate at the end of 10 years, assuming a 6% interest rate, compounded annually?

FV1 Table

FV1 = PV1 ( ) i=6%, n=10 FV1 Table

FV1 = ( ) = i=6%, n=10 200,000 1.791 $358,200

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Illustration 6: Future Value of InvestmentIllustration 6: Future Value of Investment

Jane Smith wants to invest $10,000 each year for the next 20 years, for her retirement. What balance will she have at the end of 20 years, assuming a 6% interest rate, compounded annually?

FVA Table

FVA = A ( ) = i=6%, n=20

FVA Table

FVA = ( ) = i=6%, n=20

10,000 36.786 $367,860

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Illustration 7: Future Value of InvestmentIllustration 7: Future Value of Investment

James Holliman wants to accumulate $200,000 at the end of 10 years, for his son’s education fund. What equal amount must he invest annually to achieve that balance, assuming a 6% interest rate, compounded annually?

FVA Table

FVA = A ( ) = i=6%, n=10

FVA Table

= ( ) i=6%, n=10

200,000 13.181A

A = 200,000/13.181 = $15,173.36