Chapter 6: Accounting and the Time Value of Money

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Chapter 6 Accounting and the Time Value of Money
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Introduction

• Time value of money concept
• A dollar received or paid today (the present) is
  not worth a dollar received or paid tomorrow
  (the future).
• Someone owes you 100. They say to you--Which
  would you prefer I pay you 100 today or I pay
  you 100 one year from now?
• Response--Give me the money NOW (I can invest it
  at X interest)
• ORA dollar today is worth more than a dollar
  tomorrow

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Introduction

• Concept of the time value of money applies to
• Leases
• Pensions
• Non-interest bearing notes
• Installment contracts
• Valuation of bonds
• Sinking fund provisions

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Interest

• Definitions of interest
• A fee for the use of money
• Principal x Interest Rate x Time Interest
• Simple interest
• Interest computed on principal only
• Compound interest
• Interest is computed on principal accumulated
  interest

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Interest

• Elements of the interest rate
• Pure rate of interest (system risk) --assuming no
  possibility of default and no inflation. (2-4)
• Credit risk rate of interest (individual risk)
  individual entitys risk of default. (0--5)
• Expected inflation rate of interest (inflation
  premium) decrease in the purchasing power of the
  dollar over time. (0--X)

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Types of Problems

• Single Sum. One sum (1) will be received or
  paid either in the
• Present (Present Value of a Single Sum or PV)
• Future (Future Value of a Single Sum or FV)
• Annuity. A series of equal payments at a
  constant rate of interest
• Ordinary annuityPayments or rents received at
  end of period
• Annuity dueRents received at beginning of period
• Deferred annuityRents to be received in the
  future

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Time Diagrams
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Table 6-2 PV 10,000 (.64993 x 15,386)
Table 6-1 FV 15,386(1.5386 x 10,000)
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Table 6-4 PV / oa 3,890(1,000 x 3.890)
1,000
Table 6-3 FV /.oa 5,985 ( 1,000 x 5.985)
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Table 6-5 PV / ad 4,240 ( 1,000 x
4.240) Alt Table 6-4 x 1.09
R 1,000 Table 6-3 FV x 1.09
6,523( 5.984 x 1,000 x 1.09)
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Table 6-4 PV
Table 6-3 FV
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Sample Problems
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Sample Problems
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PV FV x PVF
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FVOA R x FVFOA
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Bond Valuation