Financial accounting 10th pratt peters appendix

Appendix A: The Time Value of Money Learning Objective Describe the concept of the time value of money and be able to compute the future value of a single sum Time Value of Money •Future inflows and outflows associated with an asset or liability are predicted and adjusted in a way that reflects the time value of these inflows and outflows •The economic value of an asset or liability is its present value – that is the value of those inflows and outflows adjusted for when they will be received or paid •You would rather have a dollar now rather than a dollar a year from now because you can invest it to make it grow Interest: The Price of Money •Money, like other scarce resources, has a price • Interest •Interest is expressed as a percent over a period of time (usually a year) •Interest = Principal X Rate X Time Future Value •The future value is the amount that money will grow to at a certain interest rate after a certain amount of time •Simple Interest •Compound Interest – Interest earns interest Future Value (cont.) •Tables have been developed to expedite the calculation process as periods become much further out •The tables are the extension of the formulas Future Value (cont.) Figure A-1 Future Value Learning Objective Define an ordinary annuity and an annuity due and be able to compute their future values Future Value of Ordinary Annuities •It often happens that cash payments of equal amounts are made periodically throughout a period of time • A flow of cash payments of equal amounts paid at • periodic intervals is called an annuity If these payments are made at the end of each period it is called an ordinary annuity or annuity in arrears 10 Present Value (cont.) •As with future values, tables exist to expedite calculations •Present values for ordinary annuities and annuities due are also computed 17 Figure A-4 Present Value of an ordinary annuity (cont on next slide) 18 Figure A-4 Present Value of an ordinary annuity (cont.) 19 Figure A-5 Present Value of an annuity due (cont on next slide) 20 Figure A-5 Present Value of an annuity due (cont.) 21 Equivalent Value •There are different ways to look at problems; however, present and future value answers are the same regardless of the methodology used •The concept of equivalent value means that an investor is indifferent as to the receipt of various amounts once the time value of money is applied • In the example of the $500 annuity payments in the book, the investor would be indifferent as to an ordinary annuity of $500 for five years, $1,804 now or $3,176 five years from now 22 Equivalent Value Figure A-7 Equivalent values 23 Concept Practice 24 Learning Objective Be able to compute an implicit (internal) rate of return 25 Computing Implicit Rates of Return and Interest Rates •In many business situations it can be useful, or necessary to compute the expected or actual rate of return (or interest) generated by an investment (or note) •In these cases we want to compute the interest rate by either knowing or estimating the present value, the future cash flows, and the time period • See next slide for examples 26 Computing Implicit Rates of Return and Interest Rates (cont.) •The investment amount is $1,000 and is the present value in a project expected to produce cash receipts of $300 per year for five years Figure A-8 Computing an implicit rate of return 27 Computing Implicit Rates of Return and Interest Rates (cont.) •A purchase of property is made with a fair market value of $100,000 paying by signing a note payable requiring cash payments of $20,000 at the beginning of each year for six years Figure A-9 Computing an implicit rate of return 28 Learning Objective Explain the role of present value in the preparation of the financial statements 29 Present Value and Financial Accounting •Present value information is extremely useful to present the economic reality of a business; however, • future cash flows and future interest rates must be predicted • This is highly subjective (perhaps impossible) and not verifiable • Because present value is a goal but is often not attainable, substitute measures are used • Historical cost, fair market value, replacement cost and net realizable value are all surrogate measures 30 Wiley © 2018 31 ... Objective Explain the role of present value in the preparation of the financial statements 29 Present Value and Financial Accounting •Present value information is extremely useful to present the.. .Appendix A: The Time Value of Money Learning Objective Describe the concept of the time value of