Present Value Concepts

Present value concepts are widely used by accountants in the preparation of financial state-
ments. In fact, under International Financial Reporting Standards (IFRS), these concepts
are more widely applied than under traditional Canadian GAAP. This appendix will
explain the basics that you must be aware of to understand related topics in this text.

INTEREST RATES
Interest is payment for the use of money. It is the difference between the amount bor-
rowed or invested (the principal) and the amount repaid or collected. The amount of
interest to be paid or collected is usually stated as a rate over a specific period of time. The
rate of interest is generally stated as an annual rate.
The amount of interest involved in any financing transaction is based on three elements:
1. Principal (p): The original amount borrowed or invested
2. Interest rate (i): An annual percentage of the principal
3. Number of periods (n): The time period that the principal is borrowed or invested

Simple Interest
Simple interest is calculated on the principal amount only. It is the return on the principal
for one period. Simple interest is usually expressed as shown in Illustration PV-1.

Principal Interest Rate Number of Periods Illustration PV-1

Interest   
(p ) (i ) (n ) Simple interest formula

For example, if you borrowed $1,000 for 3 years at a simple interest rate of 9% annually,
you would pay $270 in total interest, calculated as follows:

Interest  p  i  n Year 1 Year 2 Year 3

 $1,000  9%  3 $90  $90  $90  $270
 $270
2 Present Value Concepts

Compound Interest
Compound interest is the return on (or growth of) the principal for two or more time peri-
ods. Compounding calculates interest not only on the principal but also on the interest
earned to date on that principal, assuming the interest is left on deposit (i.e., added to the
original principal amount).
To illustrate the difference between simple and compound interest, assume that you
deposit $1,000 in the Last Canadian Bank, where it will earn simple interest of 9% per
year, and you deposit another $1,000 in the First Canadian Bank, where it will earn inter-
est of 9% per year compounded annually. Also assume that in both cases you will not with-
draw any interest until three years from the date of deposit. The calculation of interest to
be received and the accumulated year-end balances are given in Illustration PV-2.

Last Canadian Bank First Canadian Bank

Accumulated Accumulated
Simple Interest Simple Year-End Compound Interest Compound Year-End
Calculation Interest Balance Calculation Interest Balance
Year 1 $1,000.00  9% $ 90.00 $1,090.00 Year 1 $1,000.00  9% $ 90.00 $1,090.00

Year 2 $1,000.00  9% 90.00 $1,180.00 Year 2 $1,090.00  9% 98.10 $1,188.10

Year 3 $1,000.00  9% 90.00 $1,270.00 Year 3 $1,188.10  9% 106.93 $1,295.03
$270.00  $25.03  $295.03
Difference

Illustration PV-2
Simple versus compound Note in Illustration PV-2 that simple interest uses the initial principal of $1,000 to
interest calculate the interest in all three years. Compound interest uses the accumulated balance
(principal plus interest to date) at each year end to calculate interest in the following year.
This explains why your compound interest account is larger: you are earning interest on
interest. For practical purposes, compounding assumes that unpaid interest earned
becomes a part of the principal. The accumulated balance at the end of each year becomes
the new principal on which interest is earned during the next year.
Assuming all else is equal (especially risk), if you had a choice between investing your
money at simple interest or at compound interest, you would choose compound interest.
In the example, compounding provides $25.03 of additional interest income.
Compound interest is used in most business situations. Simple interest is generally
applicable only to short-term situations of one year or less. Present value concepts use
compound interest.

CALCULATING PRESENT VALUES

In the previous section on compound and simple interest, the initial principal was given. It
was used to calculate the interest earned and the value of the investment at the end of three
years. The initial principal, invested at the beginning of year one, is the present
value of the investment. The value of the investment at the end of three years is the
future value of the investment.
You are probably more accustomed to being given the present value and then calculat-
ing the future value. But in business, there are many situations in which the future value is
given, and it is necessary to calculate the present value. For example, we determine the
market price of a bond by calculating the present value of the principal and interest pay-
ments. Calculating the amount to be reported for fixed and intangible assets, notes
payable, pensions, and finance lease liabilities can also involve present value calculations.
Present value calculations are always based on three variables:
 Calculating Present Values 3

1. The dollar amount to be received (the future amount or future value)

2. The length of time until the amount is received (the number of periods)
3. The interest rate (the discount rate) per period
The process of determining the present value is often referred to as discounting the
future cash flows. The word discount has many meanings in accounting, each of
which varies with the context in which it is being used. Be careful not to confuse the use
of this term.

Present Value of a Single Future Amount

In the following section, we will show three methods of calculating the present value of a
single future amount: present value formula, present value tables, and financial calculators.

Present Value Formula

To illustrate present value concepts, assume that you want to invest a sum of money at 5%
in order to have $1,000 at the end of one year. The amount that you would need to invest
today is called the present value of $1,000 discounted for one year at 5%.
The variables in this example are shown in the time diagram in Illustration PV-3.

Present Value = $952.38 Future Amount = $1,000 Illustration PV-3

Time diagram for the present
i  5% value of $1,000 discounted
n  1 year for one period at 5%
Now 1 Year

The formula used to determine the present value for any interest (discount) rate (i),
number of periods (n), and future amount (FV) is shown in Illustration PV-4.

Illustration PV-4
Future value (FV)
Present value (PV)  Present value of a single
(l  i ) n
future amount formula
 FV  (1  i ) n

In applying this formula to calculate the present value (PV ) for the above example, the
future value (FV ) of $1,000, the interest (discount) rate (i) of 5%, and the number of peri-
ods (n) of one are used as follows:

PV  $1,000  (1  5%)1
 $1,000  1.05
 $952.38

If the single future cash flow of $1,000 is to be received in two years and discounted at 5%,
its present value is calculated as follows:

PV  $1,000  (1  5%)2
 $1,000  1.052 or [($1,000  1.05)  1.05]
 $907.03

The time diagram in Illustration PV-5 shows the variables used to calculate the pres-
ent value when cash is received in two years.
4 Present Value Concepts

Present Value = $907.03 Future Amount = $1,000

Illustration PV-5
Time diagram for present i  5%
value of $1,000 discounted
for two periods at 5% n  2 years
Now 1 2 Years

Present Value Tables

The present value may also be determined through tables that show the present value of 1
for n periods for different periodic interest rates or discount rates. In Table PV-1, the rows
represent the number of discounting periods and the columns the periodic interest or dis-
count rates. The five-digit decimal numbers in the respective rows and columns are the
factors for the present value of 1.
When present value tables are used, the present value is calculated by multiplying the
future cash amount by the present value factor specified at the intersection of the number
of periods and the discount rate. For example, if the discount rate is 5% and the number of
periods is 1, Table PV-1 shows that the present value factor is 0.95238. Then the present
value of $1,000 discounted at 5% for one period is calculated as follows:
PV  $1,000  0.95238
 $952.38

For two periods at a discount rate of 5%, the present value factor is 0.90703. The
present value of $1,000 discounted at 5% for two periods is calculated as follows:
PV  $1,000  0.90703
 $907.03

Note that the present values in these two examples are identical to the amounts deter-
mined previously when using the present value formula. This is because the factors in a
present value table have been calculated using the present value formula. The benefit of
using a present value table is that it can be quicker than using the formula. If you are using
a simple calculator (not a financial calculator) or doing the calculations by hand, there are
more calculations involved as the number of periods increase, making it more tedious than
using the present value tables.
Table PV-1 can also be used if you know the present value and wish to determine the
future cash flow. The present value amount is divided by the present value factor specified
at the intersection of the number of periods and the discount rate in Table PV-1. For
example, it can easily be determined that an initial investment of $907.03 will grow to
yield a future amount of $1,000 in two periods, at an annual discount rate of 5% ($1,000 
$907.03  0.90703).
 Calculating Present Values 5

Table PV-1
PRESENT VALUE OF 1

PV  1
(1i )n
(n)
Periods 2% 21/2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 15%
1 0.98039 0.97561 0.97087 0.96154 0.95238 0.94340 0.93458 0.92593 0.91743 0.90909 0.90090 0.89286 0.86957
2 0.96117 0.95181 0.94260 0.92456 0.90703 0.89000 0.87344 0.85734 0.84168 0.82645 0.81162 0.79719 0.75614
3 0.94232 0.92860 0.91514 0.88900 0.86384 0.83962 0.81630 0.79383 0.77218 0.75131 0.73119 0.71178 0.65752
4 0.92385 0.90595 0.88849 0.85480 0.82270 0.79209 0.76290 0.73503 0.70843 0.68301 0.65873 0.63552 0.57175
5 0.90573 0.88385 0.86261 0.82193 0.78353 0.74726 0.71299 0.68058 0.64993 0.62092 0.59345 0.56743 0.49718

6 0.88797 0.86230 0.83748 0.79031 0.74622 0.70496 0.66634 0.63017 0.59627 0.56447 0.53464 0.50663 0.43233
7 0.87056 0.84127 0.81309 0.75992 0.71068 0.66506 0.62275 0.58349 0.54703 0.51316 0.48166 0.45235 0.37594
8 0.85349 0.82075 0.78941 0.73069 0.67684 0.62741 0.58201 0.54027 0.50187 0.46651 0.43393 0.40388 0.32690
9 0.83676 0.80073 0.76642 0.70259 0.64461 0.59190 0.54393 0.50025 0.46043 0.42410 0.39092 0.36061 0.28426
10 0.82035 0.78120 0.74409 0.67556 0.61391 0.55839 0.50835 0.46319 0.42241 0.38554 0.35218 0.32197 0.24718

11 0.80426 0.76214 0.72242 0.64958 0.58468 0.52679 0.47509 0.42888 0.38753 0.35049 0.31728 0.28748 0.21494
12 0.78849 0.74356 0.70138 0.62460 0.55684 0.49697 0.44401 0.39711 0.35553 0.31863 0.28584 0.25668 0.18691
13 0.77303 0.72542 0.68095 0.60057 0.53032 0.46884 0.41496 0.36770 0.32618 0.28966 0.25751 0.22917 0.16253
14 0.75788 0.70773 0.66112 0.57748 0.50507 0.44230 0.38782 0.34046 0.29925 0.26333 0.23199 0.20462 0.14133
15 0.74301 0.69047 0.64186 0.55526 0.48102 0.41727 0.36245 0.31524 0.27454 0.23939 0.20900 0.18270 0.12289

16 0.72845 0.67362 0.62317 0.53391 0.45811 0.39365 0.33873 0.29189 0.25187 0.21763 0.18829 0.16312 0.10686
17 0.71416 0.65720 0.60502 0.51337 0.43630 0.37136 0.31657 0.27027 0.23107 0.19784 0.16963 0.14564 0.09293
18 0.70016 0.64117 0.58739 0.49363 0.41552 0.35034 0.29586 0.25025 0.21199 0.17986 0.15282 0.13004 0.08081
19 0.68643 0.62553 0.57029 0.47464 0.39573 0.33051 0.27651 0.23171 0.19449 0.16351 0.13768 0.11611 0.07027
20 0.67297 0.61027 0.55368 0.45639 0.37689 0.31180 0.25842 0.21455 0.17843 0.14864 0.12403 0.10367 0.06110

Financial Calculators
Present values can also be calculated using financial calculators. A financial calculator will
perform the same calculation as a simple calculator, but it requires fewer steps and less
input. Basically, with a financial calculator, you input the future value, the discount rate,
and the number of periods, and then tell it to calculate the present value. We will not illus-
trate how to use a financial calculator because the details vary with different financial cal-
culators.
But you should know that the present value amounts calculated with a financial calcu-
lator can be slightly different than those calculated with present value tables. That is
because the numbers in a present value table are rounded. For example, in Table PV-1 the
factors are rounded to five digits. In a financial calculator, only the final answer is rounded
to the number of digits you have specified.
A major benefit of using a financial calculator is that you are not restricted to the
interest rates or numbers of periods on a present value table. In Table PV-1, present value
factors have been calculated for 13 interest rates (there are 13 columns in that table) and
the maximum number of periods is 20. With a financial calculator you could, for example,
calculate the present value of a future amount to be received in 25 periods using 5.75% as
the discount rate. Later in this appendix, we will illustrate how to partly overcome this
limitation of present value tables through a method called interpolation.
Regardless of the method used in calculating present values, a higher discount rate
produces a smaller present value. For example, using an 8% discount rate, the present
value of $1,000 due one year from now is $925.93 versus $952.38 at 5%. It should also be
recognized that the further away from the present the future cash flow is, the smaller
the present value. For example, using the same discount rate of 5%, the present value of
$1,000 due in five years is $783.53. The present value of $1,000 due in one year is $952.38.
6 Present Value Concepts

BEFORE YOU GO ON

Review It
1. Distinguish between simple and compound interest.
2. Distinguish between present value and future value.
3. What are the three variables used in calculating present value?
4. When calculating present value, what are the benefits of using present value tables and of using
financial calculators?
Do It
Suppose you have a winning lottery ticket and the lottery commission gives you the option of taking
$10,000 three years from now, or taking the present value of $10,000 now. If an 8% discount rate
is used, what is the present value of your winnings if you take the option of receiving $10,000 three
years from now? Show the calculation using either (a) the present value formula or (b) Table PV-1.
Action Plan
Note that $10,000 is the future value, the number of periods is 3, and the discount rate is 8%.
Recall that the present value of $10,000 to be received in 3 years is less than $10,000 because
interest can be earned on an amount invested today (i.e., the present value) over the next
three years.
Understand that the discount rate used to calculate the present value is the compound interest
rate that would be used to earn $10,000 in 3 years if the present value is invested today.
Draw a time diagram showing when the future value will be received, the discount rate, and the
number of periods.

PV (?) $10,000

i  8%
n3
Now 1 2 3 Years

Solution
(a) Using the present value formula:
PV  $10,000  (1  8%)3
 $10,000  1.083 or {[($10,000  1.08)  1.08]  1.08}
 $7,938.30
(b) Using the present value factor from Table PV-1:
The present value factor for three periods at 8% is 0.79383.
PV  $10,000  0.79383
 $7,938.30
Do It Again
Determine the amount you must deposit now in your savings account, paying 3% interest, in order
to accumulate $5,000 for a down payment on a hybrid electric car four years from now, when you
graduate. Show the calculation using either (a) present value formula, or (b) Table PV-1.
Action Plan
Note that $5,000 is the future value, n  4, and i  3%.
Draw a time diagram showing when the future value will be received, the discount rate, and the
number of periods.

PV (?) $5,000

i  3%
n4
Now 1 2 3 4 Years
 Present Value of a Series of Future Cash Flows (Annuities) 7

Solution
The amount you must deposit now in your savings account is the present value calculated as follows:
(a) Using the present value formula:
PV  $5,000  (1  3%)4
 $5,000  1.034 or ({[($5,000  1.03)  1.03]  1.03}  1.03)
 $4,442.43
(b) Using the present value factor from Table PV-1:
The present value factor for four periods at 3% is 0.88849.
PV  $5,000  0.88849
PV  $4,442.45
Note: The difference in the two answers is due to rounding the factors in Table PV-1.
Related exercise material: BEPV-1, BEPV-2, BEPV-3, BEPV-4, and BEPV-5.

PRESENT VALUE OF A SERIES OF

FUTURE CASH FLOWS (ANNUITIES)
The preceding discussion was for the discounting of only a single future amount.
Businesses and individuals frequently engage in transactions in which a series of equal dol-
lar amounts are to be received or paid periodically. Examples of a series of periodic receipts
or payments are loan agreements, instalment sales, mortgage notes, lease (rental) con-
tracts, and pension obligations. These series of periodic receipts or payments are called
annuities. In calculating the present value of an annuity, it is necessary to know (1) the dis-
count rate (i ), (2) the number of discount periods (n), and (3) the amount of the periodic
receipts or payments (FV).
To illustrate the calculation of the present value of an annuity, assume that you will
receive $1,000 cash annually for three years, and that the discount rate is 4%. This situa-
tion is shown in the time diagram in Illustration B-6.

PV (?) $1,000 $1,000 $1,000

Illustration PV-6

i  4% Time diagram for a

three-year annuity
n3
Now 1 2 3 Years

One method of calculating the present value of this annuity is to use the present value
formula to determine the present value of each of the three $1,000 payments and then add
those amounts as follows:
PV  [$1,000  (1  4%)1]  [$1,000  (1  4%)2]  [$1,000  (1  4%)3]
 $961.54  $924.56  $889.00
 $2,775.10

The same result is achieved by using present value factors from Table PV-1, as shown
in Illustration PV-7.

Illustration PV-7
Present Value of 1
Future Value  Factor at 4%  Present Value Present value of a series
of future cash flows
$1,000 (one year away) 0.96154 $ 961.54
1,000 (two years away) 0.92456 924.56
1,000 (three years away) 0.88900 889.00
2.77510 $2,775.10
8 Present Value Concepts

Determining the present value of each single future cash flow, and then adding the
present values, is required when the periodic cash flows are not the same in each period.
But when the future receipts are the same in each period, there are three other ways to cal-
culate present value.
The first is to use the present value of an ordinary annuity formula, as shown in
Illustration PV-8.

Illustration PV-8
Present value (PV )  Future value (FV )  1  1
Present value of an ordinary (1  i )n
annuity of 1 formula i
 $1,000  [(1  (1  (1 + 4%)3))  4%]
 $1,000  [(1  (1  (1.04)3))  0.04]
 $1,000  [(1  (1  1.124864))  0.04]
 $1,000  [(1  0.888996358)  0.04]
 $1,000  2.77509
 $2,775.09

Table PV-2
PRESENT VALUE OF AN ANNUITY OF 1

PV  1  1
(1  i )n
i
(n)
Periods 2% 21/2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 15%
1 0.98039 0.97561 0.97087 0.96154 0.95238 0.94340 0.93458 0.92593 0.91743 0.90909 0.90090 0.89286 0.86957
2 1.94156 1.92742 1.91347 1.88609 1.85941 1.83339 1.80802 1.78326 1.75911 1.73554 1.71252 1.69005 1.62571
3 2.88388 2.85602 2.82861 2.77509 2.72325 2.67301 2.62432 2.57710 2.53129 2.48685 2.44371 2.40183 2.28323
4 3.80773 3.76197 3.71710 3.62990 3.54595 3.46511 3.38721 3.31213 3.23972 3.16987 3.10245 3.03735 2.85498
5 4.71346 4.64583 4.57971 4.45182 4.32948 4.21236 4.10020 3.99271 3.88965 3.79079 3.69590 3.60478 3.35216

6 5.60143 5.50813 5.41719 5.24214 5.07569 4.91732 4.76654 4.62288 4.48592 4.35526 4.23054 4.11141 3.78448
7 6.47199 6.34939 6.23028 6.00205 5.78637 5.58238 5.38929 5.20637 5.03295 4.86842 4.71220 4.56376 4.16042
8 7.32548 7.17014 7.01969 6.73274 6.46321 6.20979 5.97130 5.74664 5.53482 5.33493 5.14612 4.96764 4.48732
9 8.16224 7.97087 7.78611 7.43533 7.10782 6.80169 6.51523 6.24689 5.99525 5.75902 5.53705 5.32825 4.77158
10 8.98259 8.75206 8.53020 8.11090 7.72173 7.36009 7.02358 6.71008 6.41766 6.14457 5.88923 5.65022 5.01877

11 9.78685 9.51421 9.25262 8.76048 8.30641 7.88687 7.49867 7.13896 6.80519 6.49506 6.20652 5.93770 5.23371
12 10.57534 10.25776 9.95400 9.38507 8.86325 8.38384 7.94269 7.53608 7.16073 6.81369 6.49236 6.19437 5.42062
13 11.34837 10.98319 10.63496 9.98565 9.39357 8.85268 8.35765 7.90378 7.48690 7.10336 6.74987 6.42355 5.58315
14 12.10625 11.69091 11.29607 10.56312 9.89864 9.29498 8.74547 8.24424 7.78615 7.36669 6.98187 6.62817 5.72448
15 12.84926 12.38138 11.93794 11.11839 10.37966 9.71225 9.10791 8.55948 8.06069 7.60608 7.19087 6.81086 5.84737

16 13.57771 13.05500 12.56110 11.65230 10.83777 10.10590 9.44665 8.85137 8.31256 7.82371 7.37916 6.97399 5.95423
17 14.29187 13.71220 13.16612 12.16567 11.27407 10.47726 9.76322 9.12164 8.54363 8.02155 7.54879 7.11963 6.04716
18 14.99203 14.35336 13.75351 12.65930 11.68959 10.82760 10.05909 9.37189 8.75563 8.20141 7.70162 7.24967 6.12797
19 15.67846 14.97889 14.32380 13.13394 12.08532 11.15812 10.33560 9.60360 8.95011 8.36492 7.83929 7.36578 6.19823
20 16.35143 15.58916 14.87747 13.59033 12.46221 11.46992 10.59401 9.81815 9.12855 8.51356 7.96333 7.46944 6.25933

The second is to use a present value of an annuity table. As illustrated in Table PV-2,
these tables show the present value of 1 to be received periodically for a given number of
periods. From Table PV-2, it can be seen that the present value factor of an annuity of
1 for three periods at 4% is 2.77509. This present value factor is the total of the three
individual present value factors, as shown in Illustration PV-7.1 Applying this present
value factor to the annual cash flow of $1,000 produces a present value of $2,775.09
($1,000  2.77509).
 Present Value of a Series of Future Cash Flows (Annuities) 9

The third method is to use a financial calculator and input the number of periods, the
interest rate, and the amount of the annual payment. When using a financial calculator to
calculate the present value of an annuity, it is also necessary to specify if the annual cash
flow is an ordinary annuity or an annuity in arrears. In an ordinary annuity, the first pay-
ment is at the end of the first period, as in our example. In an annuity in arrears, the
first payment starts immediately, at the beginning of the first period. In this appen-
dix and textbook, all of the annuity examples are ordinary annuities.

Interest Rates and Time Periods

In the preceding calculations, the discounting has been done on an annual basis using an
annual interest rate. There are situations where adjustments may be required to the inter-
est rate, the time period, or both.

Using Time Periods of Less Than One Year

Discounting may be done over shorter periods of time than one year, such as monthly,
quarterly, or semi-annually. When the time frame is less than one year, it is necessary to
convert the annual interest rate to the applicable time frame. Assume, for example, that the
investor in Illustration PV-6 received $500 semi-annually for three years instead of $1,000
annually. In this case, the number of periods (n) becomes six (three annual periods  2),
and the discount rate (i) is 2% (4%  6/12 months).
If present value tables are used to determine the present value, the appropriate present
value factor from Table PV-2 is 5.60143. The present value of the future cash flows is
$2,800.72 (5.60143  $500). This amount is slightly higher than the $2,775.09 calculated
in Illustration PV-8 because interest is calculated twice during the same year. Thus, inter-
est is compounded on the first half-years interest.

Interpolation
As previously discussed, one of the limitations of the present value tables is that the tables
contain a limited number of interest rates. But in certain situations where the factor for a
certain interest rate is not available, it can be deduced or interpolated from the tables. For
example, if you wished to find the factor to determine the present value of 1 for a 31/2%
interest rate and five periods, it would be difficult to use Table PV-1 to do so. Table PV-1
(or Table PV-2 for that matter) does not have a 31/2% interest rate column. We can, how-
ever, average the factors for the 3% and 4% interest rates to approximate the factor for a
31/2% interest rate.

Illustration PV-9
Factor, n  5, i  3% 0.86261
Factor, n  5, i  4%  0.82193 Interpolation of 3 1/2% interest
Sum of two factors  1.68454 rate factor
Average two factors  2
Factor, n  5, i  312%  0.84227
1
The difference of 0.00001 between 2.77509 and 2.77510 is due to rounding.

As previously mentioned, interpolation is only necessary when using present value tables.
If a financial calculator is used, any interest rate can be used in the calculations.
10 Present Value Concepts

BEFORE YOU GO ON

Review It
1. What is an annuity?
2. How is Table PV-2 used to calculate the present value of an annuity?
3. If an annuity is paid every three months for five years and 8% is the annual discount rate, what
are the number of periods (n ) and the interest rate (i ) used in the present value calculation?
4. When is it necessary to interpolate an interest rate?
Do It
Corkum Company has just signed a capital lease contract for equipment that requires rental payments
of $6,000 each, to be paid at the end of each of the next five years. The appropriate discount rate is
6%. What is the present value of the rental payments; that is, the amount used to capitalize the
leased equipment? Show the calculation using either (a) the present value of an annuity formula or
(b) Table PV-2.
Action Plan
Draw a time diagram showing when the future value will be received, the discount rate, and the
number of periods.

PV (?) $6,000 $6,000 $6,000 $6,000 $6,000

i  6%
n5
Now 1 2 3 4 5 Years

Note that each of the future payments is the same amount paid at even intervals; therefore, use
present value of an annuity calculations to determine the present value (i  6% and n  5).
Solution
The present value of lease rental payments of $6,000 paid at the end of each year for five years,
discounted at 6%, is calculated as follows:
(a) Using the present value of an annuity formula:
PV  $6,000  [(1  (1  (1  6%)5)  6%]
 $6,000  [(1  (1  (1.06)5)  0.06]
 $6,000  [(1  (1  1.33823)  0.06]
 $6,000  [(1 .747256)  0.06]
 $6,000  4.21236
 $25,274.16
(b) Using the present value factor from Table PV-2:
The present value factor from Table PV-2 is 4.21236 (five periods at 6%).
PV  $6,000  4.21236
PV  $25,274.16
Related exercise material: BEPV-6, BEPV-7, and BEPV-8.

APPLYING PRESENT VALUE CONCEPTS

Calculating the Market Price or Present Value
of a Bond
The present value (or market price) of a bond is a function of three variables: (1) the pay-
ment amounts, (2) the length of time until the amounts are paid, and (3) the market inter-
est rate, also known as the discount rate.
The first variable (dollars to be paid) is made up of two elements: (1) the principal
amount (a single sum), and (2) a series of interest payments (an annuity). To calculate the
present value of the bond, both the principal amount and the interest payments must be
discounted, which requires two different calculations. The present value of a bond can be
calculated using present value formulas, factors from the two present value tables, or a
financial calculator. We will illustrate only present value tables.
 Applying Present Value Concepts 11

It is important to note that the interest rate used to determine the annual or
semi-annual interest payments is fixed over the life of a bond. This is the bonds con-
tractual interest rate. The company issuing the bond chooses the specific interest rate
before issuing the bonds. But investors may use a different interest rate when determining
how much they are willing to pay (the present value) for the bonds. Investors are influ-
enced by both general economic conditions and their assessment of the company issuing
the bonds. Investors use the market interest rate to determine the present value of
the bonds. In the following sections, we will illustrate how to calculate the present value
of the bonds using a market interest rate that is equal to, greater than, or less than the con-
tractual interest rate.

Market Interest Rate Equals the Contractual Interest Rate

When the investors market interest rate is equal to the bonds contractual interest rate, the
bonds present value will equal their face value. To illustrate, assume there is a bond issue
of five-year, 6% bonds with a face value of $100,000. Interest is payable semi-annually on
January 1 and July 1. In this case, the investor will receive (1) $100,000 at maturity, and
(2) a series of 10 $3,000 interest payments [($100,000  6%)  6/12 months] over the term
of the bonds. The length of time (n) is the total number of interest periods (10 periods 
5 years  2 payments per year), and the discount rate (i) is the rate per semi-annual inter-
est period (3%  6%  6/12 months). The time diagram in Illustration PV-10 shows the
variables involved in this discounting situation.

DIAGRAM FOR PRINCIPAL Principal

Illustration PV-10
Present Amount
Value (?) $100,000 Time diagram for the present
value of a five-year, 6% bond
i  3% paying interest semi-annually

n  10
Now 1 2 3 4 5 6 7 8 9 10
Periods

DIAGRAM FOR INTEREST Interest

Present Payments
Value (?) $3,000 $3,000 $3,000 $3,000 $3,000 $3,000 $3,000 $3,000 $3,000 $3,000

i  3%
n  10
Now 1 2 3 4 5 6 7 8 9 10
Periods

The calculation of the present value of these bonds using factors from the appropriate
present value tables is shown in Illustration PV-11.

Illustration PV-11
6% Contractual Rate and 6% Market Rate
Present value of principal
Present value of principal to be received at maturity
and interest (face value)
$100,000  PV of 1 due in 10 periods (n ) at 3% (i )
$100,000  0.74409 (Table PV-1) $ 74,409
Present value of interest to be received periodically over the term of the bonds
$3,000  PV of 1 due periodically for 10 periods (n ) at 3% (i )
$3,000  8.53020 (Table PV-2) 25,591*
Present value of bonds $100,000

*Rounded
12 Present Value Concepts

Thus, when the market rate is the same as the contractual rate, the bonds will sell at
face value.

Market Interest Rate Is Greater Than the Contractual

Interest Rate
Now assume that the investors market rate of return is 8%, not 6%. The future cash flows
are again $100,000 and $3,000, respectively. These cash flows are based on the bond
contract and do not vary with the investors rate of return. But the investors rate of
return can vary, depending on available rates in the marketplace. If the market interest rate
is 8%, then the present value is calculated using this rate. In this case, 4% (8%  6/12
months) will be used because the bonds pay interest semi-annually. The present value of
the bonds is $91,889, as calculated in Illustration PV-12.

Illustration PV-12
6% Contractual Rate and 8% Market Rate
Present value of principal
Present value of principal to be received at maturity
and interest (discount)
$100,000  PV of 1 due in 10 periods (n ) at 4% (i )
$100,000  0.67556 (Table PV-1) $67,556
Present value of interest to be received periodically over the term of the bonds
$3,000  PV of 1 due periodically for 10 periods (n ) at 4% (i )
$3,000  8.11090 (Table PV-2) 24,333*
Present value of bonds $91,889

*Rounded

In this situation, the bonds will sell for $91,889, at a discount of $8,111. If the market
interest rate is greater than the contract interest rate, the bonds will always sell at a
discount. If investors determine that the bonds contract interest rate is too low, they will
compensate by paying less for the bonds. Note that they will still collect the full $100,000
at the maturity date.

Market Interest Rate Is Less Than the Contractual

Interest Rate
On the other hand, the market rate might be lower than the contract interest rate. In this
case, the interest paid on the bonds is higher than what investors expected to earn. As a
result, they will compensate by paying more for the bonds. If the market interest rate is
5%, the present value will be calculated using 2.5% (5%  6/12 months) as the discount
rate. The cash payments and number of periods remain the same. In this case, the present
value of the bonds is $104,376, calculated as in Illustration PV-13.

Illustration PV-13
6% Contractual Rate and 5% Market Rate
Present value of principal
Present value of principal to be received at maturity
and interest (premium)
$100,000  PV of 1 due in 10 periods (n ) at 2.5% (i )
$100,000  0.78120 (Table PV-1) $ 78,120
Present value of interest to be received periodically over the term of the bonds
$3,000  PV of 1 due periodically for 10 periods (n ) at 2.5% (i )
$3,000  8.75206 (Table PV-2) 26,256*
Present value of bonds $104,376

*Rounded
 Applying Present Value Concepts 13

These bonds will sell at a $4,376 premium for $104,376. If the market interest rate
is less than the contract interest rate, the bonds will always sell at a premium.
The above discussion relied on present value tables to solve present value problems.
As previously discussed, financial calculators may also be used to calculate present values
without the use of these tables. In addition, most computer spreadsheets and programs
also have built-in formulas to perform the discounting functions.

BEFORE YOU GO ON

Review It
1. Explain how the present value of a bond is determined.
2. Distinguish between the market rate of interest and the contractual rate of interest. How is each of
these used in determining the present value of a bond?
3. If the bonds have interest payable semi-annually, how is the discount rate (i ) determined? How is
the number of periods (n) determined?
4. If the market rate is greater than the contract rate, will the bonds sell at a premium or a discount?
Explain.
Do It
Forest Lake Enterprises issued $1 million of six-year, 4.5% bonds that pay interest semi-annually. The
market rate of interest for the bonds at the issue date is 4%. What cash proceeds did Forest Lake
Enterprises receive from the issue of the bonds?
Action Plan
Note that Forest Lake will be able to sell these bonds at a premium because the bonds pay higher
interest (4.5%) than the current market interest rate (4%).
Recall that the contractual interest rate is used to determine the interest payment; the
market rate is used to determine the present value.
Adjust the interest rates and number of periods for the effect of the semi-annual periods.
Use Table PV-1 to determine the present value of the principal.
Use Table PV-2 to determine the present value of the interest payments.
Solution
1. Amount to be received at maturity is the face value of the bonds, $1,000,000
2. Semi-annual interest payment  $22,500 ($1,000,000  4.5%  6/12 months)
3. Number of periods n  12 (6 years  2 payments a year)
4. Discount rate i  2% (4%  2 payments a year)
The cash proceeds that Forest Lake will receive from issuing the bonds is the present value of
principal to be received at maturity plus the present value of the interest received periodically,
calculated as follows:
Present value of principal to be received at maturity:
$1,000,000  0.78849 (PV of $1 due in 12
periods at 2% from Table PV-1) $788,490
Present value of interest to be received periodically
over the term of the bonds: $22,500  10.57534
(PV of $1 due each period for 12 periods at 2% from Table PV-2) 237,945
Present value of bonds $1,026,435

Related exercise material: BEPV-9 and BEPV-10.

Calculating the Present Value of Notes Payable

Long-term notes payable are normally repayable in a series of periodic payments. These
payments may be fixed principal payments plus interest, or blended principal and interest
payments. The accounting treatment of notes is similar to that for bonds. The present
value of a note is a function of the same three variables: (1) the payment amounts, (2) the
length of time until the amounts are paid (time to maturity date), and (3) the market inter-
est rate. Examples of long-term notes payable include unsecured notes, mortgages (which
are secured notes on real property, such as a house), and loans (e.g., student or car).
14 Present Value Concepts

Note Payable: Fixed Principal Payments Plus Interest

Lets assume Heathcote Company obtains a five-year note payable, with an 8% interest
rate, to purchase a piece of equipment costing $25,000. If we first assume that repayment
is to be in fixed principal payments plus interest, paid annually, then the payment amount
would be $5,000 ($25,000  5 years) plus 8% interest on the outstanding balance.
Illustration PV-14 details the total cost of this loan over the five-year period.

Illustration PV-14
Year 1 Year 2 Year 3 Year 4 Year 5 Total
Cost of equipment loan
Principal $5,000 $5,000 $5,000 $5,000 $5,000 $25,000
fixed principal payments
Interest1 2,000 1,600 1,200 800 400 6,000
plus interest
Total 7,000 6,600 6,200 5,800 5,400 $31,000
Present value
factor2 0.92593 0.85734 0.79383 0.73503 0.68058
Present value $6,482 $5,658 $4,922 $4,263 $3,675 $25,000

1
Interest is calculated on the outstanding principal balance at the beginning of the year. In Year 1, it is
$25,000  8%  $2,000. In Year 2, it is $20,000 ($25,000  $5,000)  8%  $1,600, and so on.
2
These factors are taken from Table PV-1, for i  8% and the appropriate n, or number of periods.

Note Payable: Blended Principal Plus Interest Payments

In the case of blended principal and interest payments, present value concepts are used to
calculate the amount of the annual payment.
If we divide the total loan amount of $25,000 by the present value factor for an annu-
ity from Table PV-2 for i  8% and n  5, then we can determine that the annual payment
is $6,261 ($25,000  3.99271). Illustration PV-15 details the total cost of this loan over the
five-year period.

Illustration PV-15
Year 1 Year 2 Year 3 Year 4 Year 5 Total
Cost of equipment loan
Payment $6,261 $6,261 $6,261 $6,261 $6,261 $31,305
blended principal and
Present value
interest payments
factor1 0.92593 0.85734 0.79383 0.73503 0.68058
Present value2 $5,797 $5,368 $4,970 $4,602 $4,261 $25,000

1
These factors are taken from Table PV-1, for i  8% and the appropriate n, or number of periods.
2
The sum of the annual present values is not exactly equal to $25,000 because of rounding. If full digits were
used, the total would be $25,000.

Comparison of Notes Payable with Fixed Principal versus

Blended Payments
Both options result in a present value cost of $25,000, but the blended principal and inter-
est payment option results in a higher total cash outflow, $31,305, compared with $31,000
for the fixed principal payments plus interest option. Note the difference also in the
annual cash flows required under each option. For example, the fixed principal and inter-
est payment option results in a higher cash outflow in the first two years and lower cash
outflow in the last three years.
These examples illustrate the effect of the timing and amount of cash flows on the
present value. Basically, payments made further away from the present are worth less in
present value terms, and payments made closer to the present are worth more.
 Applying Present Value Concepts 15

Notes Payable: Stated Interest Rate below

Market Interest Rate
In the previous two examples, the stated (contract) interest rate and the market (discount)
interest rate were both 8%. As a result of these rates being equal, the present value and the
principal amount of the loan were both $25,000. We found the same result in the previous
section on bonds payable.
Businesses sometimes offer financing with stated interest rates below market interest
rates to stimulate sales. Examples of notes with stated interest rates below market are seen
in advertisements offering no payment for two years. These zero-interest-bearing notes
do not specify an interest rate to be applied, but the face value is greater than the present
value. The present value of these notes is determined by discounting the repayment
stream at the market interest rate.
As an example, assume that a furniture retailer is offering No payment for two years,
or $150 off on items with a sticker price of $2,000. The implicit interest cost over the two
years is $150, and the present value of the asset is then $1,850 ($2,000  $150). From
Table PV-1, the effective interest rate can be determined:
PV  FV  discount factor $1,850  $2,000  0.925

Looking at the n  2 row, this would represent an interest rate of approximately 4%.
Most notes have an interest cost, whether explicitly stated or not.
If a financial calculator is used, the exact interest rate can be determined by inputting
$1,850 as the present value, $2,000 as the future value, 2 as the number of periods, and
then instructing the calculator to compute the interest rate. The result is an interest rate of
3.975%, which is very close to the 4% estimated by using the present value tables.
Also note that the purchaser should record the furniture at a cost of $1,850 even if
the purchaser chose the option of no payment for two years. In this case, the purchaser
will recognize interest expense of $74 ($1,850  4%) in the first year and $76 [($1,850 
$74)  4%] in the second year (numbers have been rounded so total interest expense over
two years is equal to $150).

Canada Student Loans

The Canadian federal government, in an effort to encourage post-secondary education,
offers loans to eligible students with no interest accruing while they maintain their student
status. When schooling is complete, the entire loan must be repaid within 10 years.
Repayment of the loan can be at a fixed rate of prime  5%, or a floating rate of prime 
2.5%. Lets assume that you attend school for four years and borrow $2,500 at the end of
each year. Upon graduation, you have a total debt of $10,000.
If you had not been eligible for the student loan, and had borrowed the money as
needed through a conventional lender who agreed to let the interest accrue at 9% over the
four years, with no payments required, how much would you owe upon graduation?
Compound interest would accrue as shown in Illustration PV-16.

Illustration PV-16
Year 1 Year 2 Year 3 Year 4
Cost of student loan with
Balance, beginning of period $ 0 $2,500 $5,225 $ 8.195
a conventional lender
Interest (@ 9%) 0 225 470 738
0 2,725 5,695 8,933
Increase in borrowings 2,500 2,500 2,500 2,500
Balance, end of period $2,500 $5,225 $8,195 $11,433
16 Present Value Concepts

The loan would total $11,433 at the end of Year 4. Note that this is the future value of
the loan at an interest rate of 9%. This amount can also be determined using present value
concepts as shown in Illustration PV-17.

Illustration PV-17
Year 1 Year 2 Year 3 Year 4
Cost of student loan with a
Balance, beginning of period (PV) $ 0 $2,500 $5,225 $ 8.195
conventional lender using
PV calculations From Table PV-1; FV  PV/0.917431 0 2,725 5,695 8,933
Increase in borrowings 2,500 2,500 2,500 2,500
Balance, end of period $2,500 $5,225 $8,195 $11,433

1
n  1, i  9%; calculation done for each year separately, based on the balance at the beginning of
each period.

A third way of calculating this future value is to first calculate the PV of an annuity of
$2,500 over four years at 9%, and to then calculate the FV of this figure, as follows:
From Table PV-2, the present value of an annuity of $2,500 per year for 4 years at 9% is:
$2,500  3.23972  $8,099.30.
From Table PV-1, the future value (4 years at 9%) of $8,099.30 is:
$8,099.30  0.70843  $11,432.75.
The benefit of having a Canada Student Loan, as opposed a loan with a conventional
lender, is shown in Illustration PV-18 by comparing the cost of repaying these two types
of loans.

Illustration PV-18
Canada Student Loan Conventional Loan
Calculation of annuity
Value of loan at the end of 4 years $10,000 $11,433
required to repay two loans
PV factor from Table PV-2: n  10; i  9% 6.41766 6.41766
Annual annuity required to pay the loan $1,558.20 $1,781.49

Under the Canada Student Loan, there is a nominal savings of $2,232.90 [10 
($1,781.49  $1,558.20)] over the life of the loan. This example uses present value calcu-
lations to illustrate the effect of not incurring interest while you are in school.

BEFORE YOU GO ON

Review It
1. Explain how calculating the present value of a note is similar to, or different from, calculating the
present value of a bond.
2. Differentiate between the two kinds of payment options on a note payable.
3. What are the benefits of having a Canada Student Loan instead of a conventional bank loan?
Do It
You are about to purchase your first car. You decide to finance the car at an annual interest rate
of 7% over a period of 48 months. If your monthly payment is $574.71, how much is the car
worth today?
Action Plan
The present value factor of an annuity for n  48 and i  0.58% (7%  12 months) is 41.76019.
Solution
The day the car is purchased, it is worth the present value of the future cash payments. The present
value of $574.71 to be paid monthly for four years, discounted at 7%, is $24,000 ($574.71 
41.76019).
Related exercise material: BEPV-11, BEPV-12, BEPV-13, BEPV-14, BEPV-15, BEPV-16, and BEPV-17.
 Applying Present Value Concepts 17

AssetsEstimating Value in Use Using

Future Cash Flows
As we have learned in a previous section, a bond can be valued based on future cash flows.
So too can an asset. In Chapter 9, you learned that companies are required to regularly
determine whether the value of property, plant, and equipment has been impaired. Recall
that an asset is impaired if the carrying amount reported on the balance sheet is greater
than its recoverable amount. The recoverable amount is either the assets fair value or its
value in use. Determining the value in use requires the application of present value con-
cepts. The computation of value in use is a two-step process: (1) future cash flows are esti-
mated, and (2) the present value of these cash flows is calculated.
For example, assume JB Company owns a specialized piece of equipment used in its
manufacturing process. JB needs to determine the assets value in use to test for impair-
ment. As the first step in determining value in use, JBs management estimates that the
equipment will last for another five years and that it will generate the following future cash
flows at the end of each year:
Year 1 Year 2 Year 3 Year 4 Year 5
$9,000 $10,000 $13,000 $10,000 $7,000

In the second step of determining value in use, JB calculates the present value of each
of these future cash flows. Using a discount rate of 8%, the present value of each future
cash flow is shown in Illustration PV-19.

Illustration PV-19
Year 1 Year 2 Year 3 Year 4 Year 5
Present value of estimated
Future cash flows $9,000 $10,000 $13,000 $10,000 $7,000
future cash flows of
Present value factor1 0.92593 0.85734 0.79383 0.73503 0.68058
specialized equipment
Present value amount $8,333 $ 8,573 $10,320 $ 7,350 $4,764
1
The appropriate interest rate to be used is based on current market rates; however, adjustments for uncertainties
related to the specific asset may be made. Further discussion on this topic is covered in more advanced texts.

The value in use of JBs specialized equipment is the sum of the present value of each
years cash flow, $39,340 ($8,333  $8,573  $10,320  $7,350  $4,764). If this amount
is less than the assets carrying amount, JB will be required to record an impairment as
shown in Chapter 9.
The present value method of estimating the value in use of an asset can also be used
for intangible assets. For example, assume JB purchases a licence from Redo Industries for
the right to manufacture and sell products using Redos processes and technologies. JB
estimates it will earn $6,000 per year from this licence over the next 10 years. What is the
value in use to JB of this licence?
Since JB expects to earn the same amount each year, Table PV-2 is used to find the
present value factor of the annuity after determining the appropriate discount rate. As
pointed out in the previous example, JB should choose a rate based on current market
rates; however, adjustments for uncertainties related to the specific asset may be required.
Assuming JB uses 8% as the discount rate, the present value factor from Table PV-2 for 10
periods is 6.71008. The value in use of the licence is $40,260 ($6,000  6.71008).
18 Present Value Concepts

BEFORE YOU GO ON

Review It
1. When is it necessary to calculate the value in use of an asset?
2. Explain the two steps in calculating the value in use of an asset.
Do It
You are attempting to estimate the value in use of your companys production equipment, which you
estimate will be used in operations for another eight years. You estimate that the equipment will
generate annual cash flows of $16,000, at the end of each year, for the remainder of its productive
life, and that 9% is the appropriate discount rate. What is the value in use of this equipment?
Action Plan
Identify future cash flows.
Use Table PV-2 to determine the present value of an annuity factor for n  8 and i  9% and
calculate the present value.
Solution
The value in use is equal to the present value of the estimated annual future cash flows for the
remaining life of the asset discounted at an appropriate discount rate.
Future annual cash flows: $16,000
Number of periods: 8
Discount rate: 9%
Present value annuity factor (n  8, i  9%): 5.53482
Present value: $88,557  $16,000  5.53482
Related exercise material: BEPV-18, BEPV-19, and BEPV-20.

Brief Exercises
Calculate simple and BEPV1 Determine the amount of interest that will be earned on each of the following investments:
compound interest.
(i ) (n )
Investment Interest Rate Number of Periods Type of Interest
(a) $100 5% 1 Simple
(b) $500 6% 2 Simple
(c) $500 6% 2 Compound

Calculate present BEPV2 Smolinski Company is considering an investment that will return a lump sum of
value of a single-sum $500,000 five years from now. What amount should Smolinski Company pay for this investment in
investment. order to earn a 4% return?

Calculate future value of BEPV3 Mehmets parents invest $8,000 in a 10-year guaranteed investment certificate (GIC) in
a single-sum investment his name. The investment pays 4% annually. How much will the GIC yield when it matures?
and demonstrate the Compare the interest earned in the first and second five-year periods, and provide an explanation for
effect of compounding. the difference.

Calculate number of BEPV4 Janet Bryden has been offered the opportunity to invest $44,401 now. The investment
periods of a single will earn 7% per year, and at the end of that time will return Janet $100,000. How many years must
investment sum. Janet wait to receive $100,000?

Calculate interest rate BEPV5 If Kerry Dahl invests $3,152 now, she will receive $10,000 at the end of 15 years. What
on single sum. annual rate of interest will Kerry earn on her investment? Round your answer to the nearest
whole number.

Calculate present BEPV6 Kilarny Company is considering investing in an annuity contract that will return $25,000
value of an annuity at the end of each year for 15 years. What amount should Kilarny Company pay for this investment
investment. if it earns a 6% return?

Determine number of BEPV7 For each of the following cases, indicate in the chart below the appropriate discount rate
periods and discount rate. (i) and the appropriate number of periods (n) to be used in present value calculations. Show calcula-
tions. The first one has been completed as an example.
 Brief Exercises 19

Annual Number Frequency (n ) Number (i ) Discount

Interest Rate of Years of Payments of periods Rate
1. 8% 3 Quarterly 3  4  12 8%  4  2%
2. 5% 4 Semi-annually
3. 7% 5 Annually
4. 4% 3 Quarterly
5. 6% 6 Semi-annually
6. 6% 15 Monthly

BEPV8 Insert the appropriate discount factor into the table below for each of the situations Interpolate discount
given. These factors have to be interpolated from Tables PV-1 and PV-2. factors.

PV of 1 PV of an Annuity of 1
(Table PV-1) (Table PV-2)
(a) n  4, i  4%
(b) n  6, i  6%

BEPV9 Cross Country Railroad Co. is about to issue $100,000 of 10-year bonds that pay a 5.5% Calculate present value
annual interest rate, with interest payable semi-annually. The market interest rate is 5%. How much of bonds.
can Cross Country expect to receive for the sale of these bonds?

BEPV10 Assume the same information as BEPV-9, except that the market interest rate is 6% Calculate present value
instead of 5%. In this case, how much can Cross Country expect to receive from the sale of these of bonds.
bonds?

BEPV11 Caledonian Company receives a six-year, $50,000 note that bears interest at 8% (paid Calculate present value
annually) from a customer at a time when the market interest rate is 7%. What is the present value of note.
of the note received by Caledonian?

BEPV12 Hung-Chao Yu Company issues a six-year, 8% mortgage note on January 1, 2011, to Calculate present value
obtain financing for new equipment. The terms provide for semi-annual instalment payments of of note.
$112,825. What were the cash proceeds received from the issue of the note?

BEPV13 You are told that a note has repayment terms of $4,000 per year for five years, with a Determine interest and
stated interest rate of 4%. How much of the total payment is for principal, and how much is for principal payments.
interest?

BEPV14 You would like to purchase a car with a list price of $30,000, and the dealer offers financ- Calculate annual
ing over a five-year period at 8%. If repayments are to be made annually, what would your annual payments.
payments be?

BEPV15 Assume the same information as in BEPV-14, except that you can only afford to make Calculate trade-in value
annual payments of $6,000. If you decide to trade in your present car to help reduce the amount of of car.
financing required, what trade-in value would you need to negotiate to ensure your annual payment
is $6,000?

BEPV16 As CFO of a small manufacturing firm, you have been asked to determine the best Compare financing options.
financing for the purchase of a new piece of equipment. If the vendor is offering repayment options
of $10,000 per year for five years, or no payment for two years followed by one payment of $46,000,
which option would you recommend? The current market rate of interest is 8%.

BEPV17 If the market rate of interest in BEPV-16 is 10%, would you choose the same option? Compare financing options.

BEPV18 Barney Googal owns a garage and is contemplating purchasing a tire retreading Calculate value of
machine for $16,100. After estimating costs and revenues, Barney projects a net cash flow from the machine for purchase
retreading machine of $2,690 annually for eight years. Barney hopes to earn a return of 11% on such decision.
investments. What is the present value of the retreading operation? Should Barney Googal purchase
the retreading machine?

BEPV19 Chang Company must perform an impairment test on its equipment. The equipment Calculate value in use
will produce the following cash flows: Year 1, $35,000; Year 2, $45,000; Year 3, $55,000. Chang for a machine.
requires a minimum rate of return of 10%. What is the value in use for this equipment?
20 Present Value Concepts

Calculate value in use BEPV20 ABC Company signs a contract to sell the use of its patented manufacturing technology
of a patent. to DEF Corp for 15 years. The contract for this transaction stipulates that DEF Corp pays ABC
$18,000 at the end of each year for the use of this technology. Using a discount rate of 9%, what is
the value in use of the patented manufacturing technology?

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