Financial accounting 3e IFRS edtion willey appendix a

WILEY IFRS EDITION Prepared by Coby Harmon University of California, Santa Barbara Westmont College E-1 APPENDIX PREVIEW Would you rather receive NT$1,000 today or a year from now? You should prefer to receive the NT$1,000 today because you can invest the NT$1,000 and earn interest on it As a result, you will have more than NT$1,000 a year from now What this example illustrates is the concept of the time value of money Everyone prefers to receive money today rather than in the future because of the interest factor Financial Accounting IFRS 3rd Edition Weygandt ● Kimmel ● Kieso E-2 APPENDIX E Time Value of Money LEARNING OBJECTIVES After studying this chapter, 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 E-3 Nature of Interest Payment for the use of money Difference Learning Objective Distinguish between simple and compound interest between amount borrowed or invested (principal) and amount repaid or collected Elements involved in financing transaction: 1.Principal (p ): Amount borrowed or invested 2.Interest Rate (i ): An annual percentage 3.Time (n ): Number of years or portion of a year that the principal is borrowed or invested E-4 LO Nature of Interest Simple Interest Interest computed on the principal only Illustration: Assume you borrow NT$5,000 for years at a simple interest rate of 6% annually Calculate the annual interest cost Illustration E-1 Interest computations FULL YEARS E-5 Interest = p x i x n = NT$5,000 x 06 x = $600 LO Nature of Interest Compound Interest   E-6 Computes interest on ► the principal and ► any interest earned that has not been paid or withdrawn Most business situations use compound interest LO Compound Interest Illustration: Assume that you deposit €1,000 in Bank Two, where it will earn simple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 E-2 Simple versus compound interest E-7 LO Future Value Concepts Future value of a single amount is the value at a future date of a given amount invested, assuming compound interest Learning Objective Solve for future value of a single amount Illustration E-3 Formula for future value FV = future value of a single amount E-8 p = principal (or present value; the value today) i = interest rate for one period n = number of periods LO Future Value of a Single Amount Illustration: If you want a 9% rate of return, you would compute the future value of a €1,000 investment for three years as follows: Illustration E-4 Time diagram E-9 LO Future Value of a Single Amount Illustration: If you want a 9% rate of return, you would compute the future value of a €1,000 investment for three years as follows: Illustration E-4 Time diagram What table we use? E-10 LO Present Value of a Long-term Note or Bond PV of Interest NT$5,000 Payment E-35 x 7.72173 Factor = NT$38,609 Present Value LO Present Value of a Long-term Note or Bond Illustration: Assume a bond issue of 10%, five-year bonds with a face value of NT$100,000 with interest payable semiannually on January and July Present value of principal NT$61,391 Present value of interest 38,609 Present value of bonds NT$100,000 E-36 LO Present Value of a Long-term Note or Bond Illustration: Now assume that the investor’s required rate of return is 12%, not 10% The future amounts are again NT$100,000 and NT$5,000, respectively, but now a discount rate of 6% (12% ÷ 2) must be used Calculate the present value of the principal and interest payments Illustration E-20 Present value of principal and interest—discount E-37 LO Present Value of a Long-term Note or Bond Illustration: Now assume that the investor’s required rate of return is 8% The future amounts are again NT$100,000 and NT$5,000, respectively, but now a discount rate of 4% (8% ÷ 2) must be used Calculate the present value of the principal and interest payments Illustration E-21 Present value of principal and interest—premium E-38 LO Computing the Present Values in a Capital Budgeting Decision Learning Objective Compute the present values in capital budgeting situations Illustration: Nagel-Siebert Trucking Company, a cross-country freight carrier, is considering adding another truck to its fleet because of a purchasing opportunity Nagel-Siebert’s primary supplier of overland rigs is overstocked and offers to sell its biggest rig for £154,000 cash payable upon delivery NagelSiebert knows that the rig will produce a net cash flow per year of £40,000 for five years (received at the end of each year), at which time it will be sold for an estimated residual value of £35,000 Nagel-Siebert’s discount rate in evaluating capital expenditures is 10% Should Nagel-Siebert commit to the purchase of this rig? E-39 LO PV in a Capital Budgeting Decision The cash flows that must be discounted to present value by Nagel-Siebert are as follows Cash Net payable on delivery (today): £154,000 cash flow from operating the rig: £40,000 for years (at the end of each year) Cash received from sale of rig at the end of years: £35,000 The time diagrams for the latter two cash flows are shown in Illustration E-22 E-40 LO PV in a Capital Budgeting Decision The time diagrams for the latter two cash are as follows: Illustration E-22 Time diagrams for Nagel-Siebert Trucking Company E-41 LO PV in a Capital Budgeting Decision The computation of these present values are as follows: Illustration E-23 Present value computations at 10% E-42 The decision to invest should be accepted LO PV in a Capital Budgeting Decision Assume Nagle-Siegert uses a discount rate of 15%, not 10% Illustration E-24 Present value computations at 15% E-43 The decision to invest should be rejected LO Using Financial Calculators N = number of periods I = interest rate per period PV = present value Learning Objective Use a financial calculator to solve time value of money problems Illustration E-25 Financial calculator keys PMT = payment FV E-44 = future value LO Using Financial Calculators Present Value of a Single Sum Assume that you want to know the present value of €84,253 to be received in five years, discounted at 11% compounded annually Illustration E-26 Calculator solution for present value of a single sum E-45 LO Using Financial Calculators Present Value of an Annuity Assume that you are asked to determine the present value of rental receipts of €6,000 each to be received at the end of each of the next five years, when discounted at 12% Illustration E-27 Calculator solution for present value of a annuity E-46 LO Using Financial Calculators Useful Applications – AUTO LOAN The loan has a 9.5% nominal annual interest rate, compounded monthly The price of the car is €6,000, and you want to determine the monthly payments, assuming that the payments start one month after the purchase Illustration E-28 9.5% ÷ 12 Calculator solution for auto loan payments 79167 E-47 LO Using Financial Calculators Useful Applications – MORTGAGE LOAN You decide that the maximum mortgage payment you can afford is €700 per month The annual interest rate is 8.4% If you get a mortgage that requires you to make monthly payments over a 15-year period, what is the maximum Illustration E-29 purchase price you can afford? 8.4% ÷ 12 Calculator solution for mortgage amount 70 E-48 LO Copyright “Copyright © 2016 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.” E-49 ... 2.48685 Factor = €2,486.85 Present Value LO Present Value of an Annuity Illustration: Kildare Company has just signed a capitalizable lease contract for equipment that requires rental payments... years at 5% interest compounded annually Learning Objective Solve for future value of an annuity Illustration E-6 Time diagram for a three-year annuity E-14 LO Future Value of an Annuity Illustration:... payments or receipts E-27 LO Present Value of an Annuity Illustration E-14 Time diagram for a three-year annuity Illustration: Assume that you will receive €1,000 cash annually for three years