Appendix A

Compound Interest and the Time-Value of Money

EXERCISES
EA-1. Future value, 4%, 6 years: $4,000 x 1.26532 = $5,061.28 Future value, 6%, 6 years: $4,000 x 1.41852 = $5,674.08 Future value, 8%, 6 years: $4,000 x 1.58687 = $6,347.48

EA-2.

Future value, 12%, 4 years: $7,500 x 1.57352 = $11,801.40 Future value, 3%, 16 quarters: $7,500 x 1.60471 = $12,035.33 Future value, 1%, 48 months: $7,500 x 1.61223 = $12,091.70 The last calculation relies on a future value factor that is not in the table at the end of Appendix A. The solution can be determined using a financial calculator or using Excel. The Excel calculation is as follows:

Cambridge Business Publishers, 2014 Solutions Manual, Appendix A A-1

EA-3.

Present value, 1% per quarter, 8 quarters: $14,000 x 0.92348 = $12,929.

EA-4.

Present value, 6%, 4 years: $24,000 x 0.79209 = $19,010.

Cambridge Business Publishers, 2014 A-2 Financial Accounting, 4th Edition

EA-5.

PV annuity, 1%, 36 months: $12,500/30.10751 = $415.18

EA-6.

The interest for the first month would be $12,500 x .01 = $125. The remaining $290.18 would go to reduce the loan balance. PV annuity, 2%, 24 quarters: $40,000 / 18.91393 = $2,114.84.

EA-7.

Cambridge Business Publishers, 2014 Solutions Manual, Appendix A A-3

EA-8.

This problem requires computation as the future value of an annuity. This can be calculated from Table 1 as follows: Future value, 6%, 5 years . Future value, 6%, 4 years . Future value, 6%, 3 years . Future value, 6%, 2 years . Future value, 6%, 1 years . Total ... 1.33823 1.26248 1.19102 1.12360 1.06000 5.97533

Annual deposit x Future value factor = Future value Deposit x 5.97533 = $20 million; $20 million / 5.97533 = $3,347,095.5 per year.

EA-9.

PV of an Annuity, 9%, 7 years: $60,000 x 5.03295 = $301,977.

Cambridge Business Publishers, 2014 A-4 Financial Accounting, 4th Edition

EA-10.

First, we must compute the payment due on December 1, 2016: Future value, 5%, 3 years: $10,000 x 1.15763 = $11,576.30. Next, we compute the present value of that payment at the market interest rate of 8%: Present value, 8%, 3 years: $11,576.30 x 0.79383 = $9,189.61. Finally, we compute the interest from December 1 through December 31, 2013: $9,189.61 x 0.08 = $735.17. Thus, in 2013, Rex Corporation would recognize sales revenue of $9,189.61 and interest income of $735.17.

EA-11. Present value, 12%, 10 years: $50,000 x 0.32197 = $16,099. PV annuity, 12%, 10 years: $200,000 x 5.65022 = $1,130,044. Maximum price Rye Company should be willing to pay is $1,130,044 + $160,985 = $1,146,143. Using Excel:

Cambridge Business Publishers, 2014 Solutions Manual, Appendix A A-5

EA-12. If Debra Wilcox chooses 26 payments, she will receive $7 million/26 = $269,230.77 per year for 26 years, with the first payment due today. This is an annuity due. Equivalently, this can be structured as an annuity in arrears by recognizing that the present value factor for the first payment is 1.0. Thus, the annuity factor is 1.0 plus the present value of an annuity for 25 payments. a. PV annuity due, 8%, 25+1 payments: $269,230.77 x (1 + 10.67478) = $3,143,210. b. PV annuity due, 4%, 25+1 payments: $269,230.77 x (1 + 15.62208) = $4,475,175.40. c. If her opportunity cost of capital is 8%, Debra Wilcox should choose the lump sum of $3,500,000 rather than take the annuity. On the other hand, if her discount rate is 4%, the annuity gives a higher present value. One way to examine this problem is to ask what opportunity cost of capital (or discount rate) would make her indifferent between the two options. This is answered by solving for the rate at which the present value of the annuity is equal to $3,500,000. Using the rate function in Excel:

So, the rate at which Debra Wilcox would be indifferent between $3,500,000 as a lump sum payment and an annuity due of $269,230.77 for 26 payments is approximately 6.68% per year.

Cambridge Business Publishers, 2014 A-6 Financial Accounting, 4th Edition

EA-13. The answer depends on Ms. Reeds opportunity cost of capital (discount rate). To determine the rate at which she would be indifferent between these two options, we divide the present value by the future value and consult Table 2: $60,000/$100,000 = 0.60000. From Table 2, the present value of $1 received five years in the future discounted at 10% is 0.62092. At 11%, the present value is 0.59345. Thus the discount rate at which she would be indifferent is between 10% and 11%. Alternatively, we can use the rate function in Excel:

The rate at which she would be indifferent is 10.76%. So, if her discount rate is higher than that, she should accept the $60,000 today. If her rate is less than 10.76%, she should choose the deferred payment of $100,000.

Cambridge Business Publishers, 2014 Solutions Manual, Appendix A A-7

EA-14. This calculation (and the calculation in A13) can be done with either the present value or future value tables, depending on which value is placed in the numerator and which is in the denominator. Using the present value tables: $400,000/$955,000 = 0.41885 The present value factor for 11%, 8 years is 0.43393. The present value factor for 12%, 8 years is 0.40388. Hence, the required rate of return on the investment is between 11% and 12%. Using Excel, we can determine the exact rate:

Cambridge Business Publishers, 2014 A-8 Financial Accounting, 4th Edition

EA-15. This question can be answered by adding the future values at 12%: Amount Deposited $360,000 60,000 60,000 60,000 60,000 Future Value Factor 1.57352 1.40493 1.25440 1.12000 1.00000 Future Value $566,467 84,296 75,264 67,200 60,000 $853,227

Date: July 1, 2013 .. June 30, 2014 .. June 30, 2015 .. June 30, 2016 .. June 30, 2017 .. Value on June 30, 2017

EA-16. a. Present value of an annuity, 10%, 20 years: Payment = $10,000,000/8.51356 = $1,174,597

b. $10,000,000 x 10% = $1,000,000. c. Present value of an annuity, 10%, 10 years: $1,174,597 x 6.14457 = $7,217,392

Cambridge Business Publishers, 2014 Solutions Manual, Appendix A A-9

EA-17. a. (i) Present value 2%, 10 periods: $200,000 x 0.82035 = $164,070 PV annuity, 2%, 10 periods: ($200,000x.05/2) x 8.98259 = $44,913 $164,070 + $44,913 = $208,983.

(ii) Present value 3%, 10 periods: $200,000 x 0.74409 = $148,818 PV annuity, 3%, 10 periods: ($200,000x.05/2) x 8.53020 = $42,651 $148,818 + $42,651 = $191,469.

continued next page

Cambridge Business Publishers, 2014 A-10 Financial Accounting, 4th Edition

EA-17. concluded b. Present value 4%, 6 periods: $200,000 x 0.79031 = $158,062 PV annuity, 4%, 6 periods: ($200,000x.05/2) x 5.24214 = $26,211 $158,062 + $26,211 = $184,273.

Cambridge Business Publishers, 2014 Solutions Manual, Appendix A A-11

EA-18. a. PV annuity, 9%, 20 years: $450,000 x 9.12855 = $4,107,847.

b. PV annuity due, 9%, 19+1 years: $450,000 x (1+ 8.95011) = $4,477,551.

Cambridge Business Publishers, 2014 A-12 Financial Accounting, 4th Edition

EA-19. a. A: 1 + PV annuity, 5%, 5 years: $8,000 x (1 + 4.32948) = $42,635.84 B: PV annuity, 5%, 5 years: $9,000 x 4.32948 = $38,965.32 PV annuity, 5%, 2 years: $2,000 x 1.85941 = $3,718.82 $38,965.32 + $3,718.82 = $42,684.14 at 5% interest. Alternative A appears to be the cheaper alternative. b. A: 1 + PV annuity, 7%, 5 years: $8,000 x (1 + 4.10020) = $40,801.60 B: PV annuity, 7%, 5 years: $9,000 x 4.10020 = $36,901.80 PV annuity, 7%, 2 years: $2,000 x 1.80802 = $3,616.04 $36,901.80 + $3,616.04 = $40,517.84. Alternative B appears to be the cheaper alternative at 7% interest.

EA-20. A: PV annuity 2%, 24 quarters: $3,000 x 18.91393 = $56,741.79 B: PV annuity 8%, 5 years: $14,300 x 3.99271 = $57,095.75 Payment alternative A appears to be cheaper at an 8% discount rate. However, this is misleading because the effective discount rate is higher in alternative A. If the same discount rate (2% compounded quarterly) is used for both calculations, the annuity factor for alternative B would be lower. To compute the appropriate discount rate, add the present value of a single payment for each of the five payments as follows: 2%, 4 quarters 2%, 8 quarters 2%, 12 quarters 2%, 16 quarters 2%, 20 quarters Total 0.92385 0.85349 0.78849 0.72845 0.67297 3.96725

$14,300 x 3.96725 = $56,731.68, hence, alternative B is slightly cheaper.

Cambridge Business Publishers, 2014 Solutions Manual, Appendix A A-13