
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= principal
 i= 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
PVAD = R (1 + i) PVFOA _{n,i}

Future value of an Annuity Due
FVAD = R (1 + i) (FVFOA _{n,i})

Future Value of an Ordinary Annuity
FVOA = R (FVFOA _{n,i})

Present value of an Ordinary Annuity
PVOA = R (PVFOA _{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
 notes
 leases
 pensions
 longterm assets
 sinking funds
 business combinations
 disclosures
 installment 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 longterm bonds valued?
 There are 2 cash flows:
 periodic interest pmts
 principle (face value) paid at maturity
 The periodic pmts represent an annuity
 The principal is a single sum problem
Valuation sums the two

How does the effectiveinterest 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.

