# Chapter 6

 What is the time value of money? Indicates a relationship between time and money- that a dollar received today is worth more than a dollar promised at some time in the future due to the opportunity to invest today's dollar and earn interest on the investment Define and Calculate Simple Interest Simple interest is money earned on the principal only Interest = p x i x n where p= principali= annual interest rate n= number of periods Define Compound Interest Interest is calculated on the principal AND the interest FV = PV (FVF n,i) Future Value of a single sum where FV= future value PV= present value FVF n,i= future value factor for n periods at i interest Present value of a single sum PV = FV (PVF n,i) where PV= present value FV= future value PVF n,i= present value factor for n periods at i interest Future value of a single sum FV = PV (FVF n,i) Present Value of an Annuity Due PV-AD = R (1 + i) PVF-OA n,i Future value of an Annuity Due FV-AD = R (1 + i) (FVF-OA n,i) Future Value of an Ordinary Annuity FV-OA = R (FVF-OA n,i) Present value of an Ordinary Annuity PV-OA = R (PVF-OA n,i) The 3 components of interest PURE rate of interest EXPECTED INFLATION rate of interest CREDIT RISK rate of interest PURE rate of interest The amount a lender would charge if there were no possibilities of default and no expectation of inflation EXPECTED inflation rate of interest Interest rates are increased in an inflationary economy to compensate for the loss in purchasing power of the dollars they are being repaid. CREDIT RISK rate of interest The rate of interest based on an enterprise's financial stability, profitability, etc. What are the primary characteristics of an annuity? An annuity involves EQUAL payments, called RENTS, made at REGULAR time intervals and earns compounding interest. The rents can occur at the beginning (Annuity due) or end (OA) of the time period. How is the Future/Present value of an OA table used to determine the FV/PV of an Annuity Due? The factor (1 + i) is figured into the OA formulas. Applications of time value concepts in accounting notesleasespensionslong-term assetssinking fundsbusiness combinationsdisclosuresinstallment contracts How are the number of periods (n) and rate of interest for a single period (i) determined for the time value formulas? n is the # of compounding periods. For 3 years, annual n=3, semi ann n=6 and quarterly n=12 i is the interest rate for a single period. For a 10% rate, if compounded annually, i = 10%, if semiannually, i = 5% What is effective yield/interest rate The interest earned divided by the principal gives the effective yield. What is discounting? The fact that the present value is always a smaller amount than the known future value because the company moves backward in time What is accumulation? The process of determining a future value by moving forward in time How are long-term bonds valued? There are 2 cash flows:periodic interest pmtsprinciple (face value) paid at maturity The periodic pmts represent an annuityThe principal is a single sum problem Valuation sums the two How does the effective-interest method of amortization of a bond discount or premium work? The bond discount or premium is written off to interest expense over the life of the bond. Authorkchiccarine ID37325 Card SetChapter 6 DescriptionAccounting and the time value of money Updated2010-12-11T20:57:05Z Show Answers