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Time Value of Money Concepts

Time Value of Money Concepts. Sid Glandon, DBA, CPA Associate Professor of Accounting. Accounting Measurements using Present Value Concepts. Notes Leases Amortization of premiums and discounts Pensions and other postretirement benefits Long-term assets Sinking funds Business combinations

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Time Value of Money Concepts

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  1. Time Value of Money Concepts Sid Glandon, DBA, CPA Associate Professor of Accounting

  2. Accounting Measurements using Present Value Concepts • Notes • Leases • Amortization of premiums and discounts • Pensions and other postretirement benefits • Long-term assets • Sinking funds • Business combinations • Disclosures • Installment contracts

  3. Variables in Interest Computation • Principal • Amount borrowed or invested • Interest rate • Percentage applied to outstanding principal • Time • Number of periods that the principal is outstanding

  4. Components of Interest • Pure (risk free) rate (2%-4%) • Credit risk rate (0%-5%) • Expected inflation (0%-?)

  5. Simple Interest • Interest = p * i * n • p=principal • i=rate of interest for a single period • n=number of periods

  6. Example: Simple Interest

  7. Compound Interest • Computed on • Principal balance, plus • Accumulated interest not withdrawn

  8. Example: Compound Interest

  9. Interest RatesFrequency of Compounding • Interest rate of 12% per year: • Annual • Compounded once per year at 12% • Semi-annual • Compounded twice per year at 6% • Quarterly • Compounded four times per year at 3% • Monthly • Compounded twelve times per year at 1%

  10. Compound Interest Tables • Future value of $1 • Present value of $1 • Future value of ordinary annuity of $1 • Present value of ordinary annuity of $1 • Future value of annuity due of $1 • Present value of annuity due of $1

  11. Annuity Computations • Requires that • Periodic payments or receipts always be of the same amount • Interval between payments or receipts be the same • Interest be compounded once each interval

  12. Ordinary Annuities • Payments or receipts are always made at the end of the period • Use the FVOA or PVOA tables

  13. Annuity Due • Payments or receipts are always made at the beginning of the period • Multiply 1 plus the interest rate times the table value of an ordinary annuity

  14. Future Value of $1

  15. Present Value of $1

  16. Future Value of Ordinary Annuity

  17. Present Value of Ordinary Annuity

  18. Future Value of Annuity Due

  19. Present Value of Annuity Due

  20. Issue Price of Bonds • PV of Principal • Using market rate of interest • PV of Annuity • Annuity = Principal times stated interest rate • Using market rate of interest • Equals Issue Price of Bonds

  21. Fact Pattern: Issue Price of Bonds • Face Amount, $100,000 • Stated interest rate, 8% • Length of bonds, 10 years • Interest payments, semi-annual • Market interest rate, 10%

  22. Issue Price of Bonds

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