Basic Time Diagram

1. Basic Time Diagram

2. Time Value Concepts • Underlying logic – if a company had a dollar today, it could invest the dollar, earn a return on it, and have more than a dollar at a future point in time. • When converting future period cash flows into current period equivalents, an adjustment is made for the (expected) returns that a company could have earned had they received the cash flow in the current period. • Adjustment process is referred to as “discounting” future period cash flows.

3. Time Value Concepts • Interest rate – cost associated with use of money expressed as a percentage of a monetary unit per period of time. • Components of interest rates • Real interest rate –lenders/investors are foregoing current period consumption in exchange for future period consumption. • Inflation – prices have a tendency to increase over time, thus the purchasing power of money received in the future may be less. • Uncertainty – investors will require higher interest rate for uncertain outcomes. • Determining appropriate interest rate to use when making TVM calculation is generally a difficult task.

4. Compound Interest Tables • Future value of $1 (TABLE 6-1) • Present value of $1 (TABLE 6-2) • Future value of an ordinary annuity of $1 (TABLE 6-3) • Present value of an ordinary annuity of $1 (TABLE 6-4) • Present value of an annuity due of $1 (TABLE 6-5)

5. Present-Value Based Accounting Measurements • Notes – receivable (Ch. 7) and payable (bonds) • Leases • Pensions and other postretirement benefits • Long-term Assets – Measuring impairment of assets (Ch. 11) • Sinking Funds • Business Combinations • Disclosures • Installment Contracts

6. Complex Situations Deferred Annuities: • Rents begin after a specified number of periods (e.g. pensions) Valuation of Long-term Bonds: • Two cash flows: principal paid at maturity and periodic interest payments