Appendix G

G-1
Appendix
G Time Value of Money

Accounting in Action
Learning Objectives
After studying this chapter, you should be able to:
[1] Distinguish between simple and compound interest.
[2] Solve for future value of a single amount.
[3] Solve for future value of an annuity.
[4] Identify the variables fundamental to solving present value problems.
[5] Solve for present value of a single amount.
[6] Solve for present value of an annuity.
[7] Compute the present value of notes and bonds.
[8] Compute the present values in capital budgeting situations.
[9] Use a financial calculator to solve time value of money problems.
G-2
Basic Time Value Concepts
Time Value of Money

Would you rather receive $1,000 today or in a year
from now?
Today! “Interest Factor”
G-3
Nature of Interest
 Payment for the use of money.
 Difference 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.
G-4 LO 1
Nature of Interest
Simple Interest
 Interest computed on the principal only.
Illustration: Assume you borrow $5,000 for 2 years at a simple

interest rate of 12% annually. Calculate the annual interest cost.
Illustration G-1
Interest computations
Interest = p x i x n
2 FULL
= $5,000 x .12 x 2
YEARS
= $1,200
G-5 LO 1
Nature of Interest
Compound Interest
 Computes interest on
► the principal and
► any interest earned that has not been paid or

withdrawn.
 Most business situations use compound interest.
G-6 LO 1
Nature of Interest - 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 interest until three years from the date of deposit.
Illustration G-2
Simple versus compound interest
Year 1 $1,000.00 x 9% $ 90.00 $ 1,090.00
Year 2 $1,090.00 x 9% $ 98.10 $ 1,188.10
Year 3 $1,188.10 x 9% $106.93 $ 1,295.03
G-7 LO 1
Appendix

Learning Objectives
G-8
Future Value Concepts
Future Value of a Single Amount

Future value of a single amount is the value at a future
date of a given amount invested, assuming compound
interest.
Illustration G-3
Formula for future value
FV = future value of a single amount

p = principal (or present value; the value today)
i = interest rate for one period
n = number of periods
G-9 LO 2
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 G-4
Time diagram
G-10 LO 2
Alternate
Future Value of a Single Amount Method

compute the future value of a $1,000 investment for three
years as follows:
Illustration G-4
Time diagram
What table do we use?
G-11 LO 2
What factor do we use?
$1,000 x 1.29503 = $1,295.03

Present Value Factor Future Value
G-12 LO 2
Illustration G-5
Illustration: Demonstration problem—
Using Table 1 for FV of 1
G-13 LO 2
$20,000 x 2.85434 = $57,086.80

Present Value Factor Future Value
G-14 LO 2
Appendix

Learning Objectives
G-15
Future Value Concepts
Future Value of an Annuity

Future value of an annuity is the sum of all the payments
(receipts) plus the accumulated compound interest on
them.
Necessary to know the

1. interest rate,
2. number of payments (receipts), and
3. amount of the periodic payments (receipts).
G-16 LO 3
Illustration: Assume that you invest $2,000 at the end of each

year for three years at 5% interest compounded annually.
Illustration G-6
Time diagram for a three-year annuity
G-17 LO 3
Illustration:
Invest = $2,000
i = 5%
n = 3 years
Illustration G-7
G-18 Advance slide in presentation mode to reveal answers. LO 3

When the periodic payments (receipts) are the same in each

period, the future value can be computed by using a future
value of an annuity of 1 table.
Illustration G-8
Demonstration problem—
Illustration: Using Table 2 for FV of an
annuity of 1
G-19 LO 3
$2,500 x 4.37462 = $10,936.55

Payment Factor Future Value
G-20 LO 3
Appendix

Learning Objectives
G-21
Present Value Concepts
Present Value Variables

The present value is the value now of a given amount to
be paid or received in the future, assuming compound
interest.
Present value variables:

1. Dollar amount to be received (future amount).
2. Length of time until amount is received (number of

periods).
3. Interest rate (the discount rate).
G-22 LO 4
Appendix

Learning Objectives
G-23
Present Value of a Single Amount

Illustration G-9
Formula for present value
Present Value = Future Value ÷ (1 + i )n

p = principal (or present value)
i = interest rate for one period
n = number of periods
G-24 LO 5

compute the present value of $1,000 for one year as
follows:
Illustration G-10
Finding present value if
discounted for one period
G-25 LO 5
Illustration G-10
discounted for one period
Illustration: If you want a 10% rate of return, you can also

compute the present value of $1,000 for one year by using
a present value table.
G-26 LO 5
$1,000 x .90909 = $909.09

Future Value Factor Present Value
G-27 LO 5
Illustration G-11
discounted for two period
Illustration: If the single amount of $1,000 is to be received in

two years and discounted at 10% [PV = $1,000 ÷ (1 + .102], its
present value is $826.45 [($1,000 ÷ 1.21).

G-28 LO 5
$1,000 x .82645 = $826.45

G-29 LO 5
Illustration: Suppose you have a winning lottery ticket and the state gives
you the option of taking $10,000 three years from now or taking the present
value of $10,000 now. The state uses an 8% rate in discounting. How much
will you receive if you accept your winnings now?
$10,000 x .79383 = $7,938.30

G-30 LO 5
Illustration: Determine the amount you must deposit today in your SUPER
savings account, paying 9% interest, in order to accumulate $5,000 for a
down payment 4 years from now on a new car.
$5,000 x .70843 = $3,542.15

G-31 LO 5
Appendix

Learning Objectives
G-32
Present Value of an Annuity

The value now of a series of future receipts or payments,
discounted assuming compound interest.
Necessary to know the:

1. Discount rate,
2. Number of payments (receipts).
3. Amount of the periodic payments or receipts.
G-33 LO 6
Illustration G-14
Time diagram for a three-year annuity
Illustration: Assume that you will receive $1,000 cash

annually for three years at a time when the discount rate is
10%. Calculate the present value in this situation.
G-34 LO 6
$1,000 x 2.48685 = $2,484.85
G-35 LO 6
Illustration: Kildare Company has just signed a capitalizable lease

contract for equipment that requires rental payments of $6,000 each, to
be paid at the end of each of the next 5 years. The appropriate discount
rate is 12%. What is the amount used to capitalize the leased
equipment?
$6,000 x 3.60478 = $21,628.68
G-36 LO 6
Illustration: Assume that the investor received $500 semiannually

for three years instead of $1,000 annually when the discount rate
was 10%. Calculate the present value of this annuity.
$500 x 5.07569 = $2,537.85

G-37 LO 6
Appendix

Learning Objectives
G-38
Present Value of a Long-term Note or Bond
Two Cash Flows:

 Periodic interest payments (annuity).
 Principal paid at maturity (single sum).
100,000
$5,000 5,000 5,000 5,000 5,000 5,000

.....
0 1 2 3 4 9 10
G-39 LO 7
Illustration: Assume a bond issue of 10%, five-year bonds with

a face value of $100,000 with interest payable semiannually on
January 1 and July 1. Calculate the present value of the
principal and interest payments.
100,000
$5,000 5,000 5,000 5,000 5,000 5,000

.....
0 1 2 3 4 9 10
G-40 LO 7
PV of Principal
$100,000 x .61391 = $61,391

Principal Factor Present Value
G-41 LO 7
PV of Interest
$5,000 x 7.72173 = $38,609

Payment Factor Present Value
G-42 LO 7
Illustration: Assume a bond issue of 10%, five-year bonds with a

face value of $100,000 with interest payable semiannually on
January 1 and July 1.
Present value of Principal $61,391

Present value of Interest 38,609
Bond current market value $100,000
Date Account Title Debit Credit

Cash 100,000
Bonds Payable 100,000
G-43 LO 7
Illustration: Now assume that the investor’s required rate of return

is 12%, not 10%. The future amounts are again $100,000 and
$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 G-20
Present value of principal
and interest—discount
G-44 LO 7
Illustration: Now assume that the investor’s required rate of

return is 8%. The future amounts are again $100,000 and $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 G-21
Present value of principal
and interest—premium
G-45 LO 7
Appendix

Learning Objectives
G-46
Computing the Present Values in a Capital

Budgeting Decision
Illustration: Nagel-Siebert Trucking Company, a cross-country freight
carrier in Montgomery, Illinois, is considering adding another truck to its
fleet because of a purchasing opportunity. Navistar Inc., Nagel-Siebert’s
primary supplier of overland rigs, is overstocked and offers to sell its
biggest rig for $154,000 cash payable upon delivery. Nagel-Siebert 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 salvage 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?
G-47 LO 8
Present Value in a Capital Budgeting Decision
The cash flows that must be discounted to present value by

Nagel-Siebert are as follows.
 Cash payable on delivery (today): $154,000.
 Net cash flow from operating the rig: $40,000 for 5 years
(at the end of each year).
 Cash received from sale of rig at the end of 5 years:

$35,000.
The time diagrams for the latter two cash flows are shown in
Illustration G-22 which follows.
G-48 LO 8
The time diagrams for the latter two cash are as follows:
Illustration G-22
Time diagrams for Nagel-
Siebert Trucking Company
G-49 LO 8
The computation of these present values are as follows:

Illustration G-23
Present value computations at 10%
The decision to invest should be accepted.

G-50 Advance slide in presentation mode to reveal answer. LO 8
Assume Nagle-Siegert uses a discount rate of 15%, not 10%.

Illustration G-24
Present value computations at 15%
The decision to invest should be rejected.
G-51 Advance slide in presentation mode to reveal answer. LO 8

Appendix

Learning Objectives
G-52
Using Financial Calculators
Illustration G-25
Financial calculator keys
N = number of periods
I = interest rate per period
PV = present value
PMT = payment
FV = future value
G-53 LO 9
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 G-26
Calculator solution for
present value of a single sum
G-54 LO 9

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 G-27
present value of an annuity
G-55 LO 9
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 G-28
auto loan payments
G-56 LO 9
Useful Applications – Mortgage Loan Amount

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
purchase price you can afford? Illustration G-29
mortgage amount
G-57 LO 9
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G-58

Appendix G

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G-1

G Time Value of Money

Time Value of Money

Today! “Interest Factor”

 Payment for the use of money.

 Difference between amount borrowed or invested

Elements involved in financing transaction:

2. Interest Rate (i): An annual percentage.

3. Time (n): Number of years or portion of a year that

Illustration: Assume you borrow $5,000 for 2 years at a simple

► any interest earned that has not been paid or

 Most business situations use compound interest.

Illustration: Assume that you deposit $1,000 in Bank Two, where it

Year 1 $1,000.00 x 9% $ 90.00 $ 1,090.00

Year 2 $1,090.00 x 9% $ 98.10 $ 1,188.10

Year 3 $1,188.10 x 9% $106.93 $ 1,295.03

G Time Value of Money

Future Value of a Single Amount

FV = future value of a single amount

Illustration: If you want a 9% rate of return, you would

Illustration: If you want a 9% rate of return, you would

What table do we use?

What factor do we use?

$1,000 x 1.29503 = $1,295.03

What table do we use?

$20,000 x 2.85434 = $57,086.80

G Time Value of Money

Future Value of an Annuity

Necessary to know the

2. number of payments (receipts), and

3. amount of the periodic payments (receipts).

Illustration: Assume that you invest $2,000 at the end of each

G-18 Advance slide in presentation mode to reveal answers. LO 3

When the periodic payments (receipts) are the same in each

What factor do we use?

$2,500 x 4.37462 = $10,936.55

G Time Value of Money

Present Value Variables

Present value variables:

2. Length of time until amount is received (number of

3. Interest rate (the discount rate).

G Time Value of Money

Present Value of a Single Amount

Present Value = Future Value ÷ (1 + i )n

Illustration: If you want a 10% rate of return, you would

Illustration: If you want a 10% rate of return, you can also

What table do we use?

What factor do we use?

$1,000 x .90909 = $909.09

Illustration: If the single amount of $1,000 is to be received in

What table do we use?

What factor do we use?

$1,000 x .82645 = $826.45

$10,000 x .79383 = $7,938.30

$5,000 x .70843 = $3,542.15

G Time Value of Money

Present Value of an Annuity

Necessary to know the:

2. Number of payments (receipts).

3. Amount of the periodic payments or receipts.

Illustration: Assume that you will receive $1,000 cash

What table do we use?

What factor do we use?