Chapter 6 Time Value of Money Concepts
93. Bison Mfg. is considering two options for purchasing comparable machinery. Machine 1 will
cost $27,500 plus an annual maintenance fee of $1,500 per year for four years. Machine 2 will
cost $25,000 with maintenance being an add-on charge. The estimated cost of maintenance is
$1,000 the first year, $3,000 the second year, and $4,000 the third year and the fourth year.
Assume the purchase cost is paid up front, but that maintenance is paid for at the end of each
year. Interest is at 10%. Ignore income taxes and residual values.
Required: Determine which machine should be chosen based on present value considerations.
94. On May 1, 2016, Bo Smith, proud father of newborn son Bobo, purchased $200,000 in zero–
coupon bonds that mature on May 1, 2036. The bonds pay no interest during the period of
time they are outstanding. The interest rate for such borrowings is at 9%. Interest compounds
annually.
Required: Calculate the price Bo paid for the bonds.
95. On February 1, 2016, Lynda Brown, proud mother of newborn daughter Goldie, purchased
$600,000 in zero-coupon bonds that mature on February 1, 2036. The bonds pay no interest
during the period of time they are outstanding. The interest rate for such borrowings is at 12%.
Required: Calculate the price Lynda paid for the bonds.
96. On the last day of its fiscal year ending December 31, 2016, the Boatright Ship Builders
completed two financing arrangements. The funds provided by these initiatives will allow the
company to expand its operations.
1. Boatright issued 6% stated rate bonds with a face amount of $200 million. The bonds
mature on December 31, 2036 (20 years). The market rate of interest for similar bond
issues was 8% (4% semiannual rate). Interest is paid semiannually (3%) on June 30 and
December 31, beginning on June 30, 2017.
2. The company leased two manufacturing facilities. Lease A requires 10 annual lease
payments of $50,000 beginning on January 1, 2017. Lease B also is for 10 years,
beginning January 1, 2017. Terms of the lease require seven annual lease payments of
$60,000 beginning on January 1, 2020. Accounting standards require both leases to be
recorded as liabilities for the present value of the scheduled payments. Assume that an
8% interest rate properly reflects the time value of money for the lease obligations.
Chapter 6 Time Value of Money Concepts
Required:
What amounts will appear in Boatright’s December 31, 2016, balance sheet for the bonds and
for the leases?
Answer:
Chapter 6 Time Value of Money Concepts
97. White & Decker Corporation’s 2016 financial statements included the following information
in the long-term debt disclosure note:
($ in millions)
2016
Zero-coupon subordinated debentures, due 2031: $275
The disclosure note stated the debenture bonds were issued late in 2011 and have a maturity
value of $500 million. The maturity value indicates the amount that White & Decker will pay
bondholders in 2031. Each individual bond has a maturity value (face amount) of $1,000.
Zero-coupon bonds pay no cash interest during the term to maturity. The company is
“accreting” (gradually increasing) the issue price to maturity value using the bonds’ effective
interest rate computed on an annual basis.
Required:
1. Determine the effective interest rate on the bonds.
2. Determine the issue price in late 2011 of a single, $1,000 maturity-value bond.
Answer:
Chapter 6 Time Value of Money Concepts
98. Santa Cruz Oil is obligated to the State of Nevada to restore leased land to its original
condition after its oil drilling activities are over in four years. The cash flow possibilities are
probabilities for the restoration costs in four years are as follows:
Cash Outflow Probability
$20 million 20%
30 million 40%
40 million 30%
50 million 10%
The company’s credit-adjusted risk-free interest rate is 6%.
Required:
Calculate the liability that Santa Cruz must record at the beginning of the project for the
restoration costs.
99. Jackpot Mining is obligated to the State of California to restore leased land to its original
condition after its mining activities are over in six years. The cash flow possibilities and
probabilities for the restoration costs in six years are as follows:
Cash Outflow Probability
$ 5 million 10%
10 million 30%
12 million 40%
15 million 20%
Chapter 6 Time Value of Money Concepts
The company’s credit-adjusted risk-free interest rate is 4%.
Required:
Calculate the liability that Jackpot must record at the beginning of the project for the
restoration costs.
100. Incognito Company is contemplating the purchase of a machine that provides it with net after–
tax cash savings of $80,000 per year for five years. Interest is 8%. Assume the cash savings
occur at the end of each year.
Required: Calculate the present value of the cash savings.
101. Samson Inc. is contemplating the purchase of a machine that will provide it with net after-tax
cash savings of $100,000 per year for eight years. Interest is 10%. Assume the cash savings
occur at the end of each year.
Required: Calculate the present value of the cash savings.
Chapter 6 Time Value of Money Concepts
102. Under the MLB deferred compensation plan, payments made at the end of each year
accumulate up to retirement and then retirees are given two options. Option 1 allows the
retiree to select the amount of the annual payment to be received, and option 2 allows the
retiree to specify over how many years payments are to be received. Assume Sosa has had
$5,000 deposited at the end of each year for 40 years, and that the long-term interest rate has
been 7%.
Required:
a. How much has accumulated in Sosa’s deferred compensation account?
b. How much will Sosa be able to withdraw at the beginning of each year if he elects
to receive payments for 20 years?
c. For how many years will Sosa be able to receive payments if he chooses to
receive $115,000 per year at the beginning of each year?
Answer:
103. Under the NBA deferred compensation plan, payments made at the end of each year
accumulate up to retirement and then retirees are given two options. Option 1 allows the
retiree to select the amount of the annual payment to be received, and option 2 allows the
retiree to specify over how many years payments are to be received. Assume Rodman has had
$6,000 deposited at the end of each year for 30 years, and that the long-term interest rate has
been 8%.
Required:
Chapter 6 Time Value of Money Concepts
a. How much has accumulated in Rodman’s deferred compensation account?
b. How much will Rodman be able to withdraw at the beginning of each year if he elects to
receive payments for 15 years?
c. How many years will Rodman be able to receive payments if he chooses to receive
$65,000 per year at the beginning of each year?
Answer:
104. ABC Company will issue $5,000,000 in 6%, 10-year bonds when the market rate of interest is
8%. Interest is paid semiannually.
Required: Determine how much cash ABC Company will realize from the bond issue.
Chapter 6 Time Value of Money Concepts
105. DEF Company will issue $2,000,000 in 10%, 10-year bonds when the market rate of interest
is 12%. Interest is paid semiannually.
Required: Determine how much cash DEF Company should realize from the bond issue.
106. GHI Company will issue $2,000,000 in 8%, 10-year bonds when the market rate of interest is
6%. Interest is paid semiannually.
Required: Determine how much cash GHI Company should realize from the bond issue.
107. JKL Company will issue $2,000,000 in 12%, 10-year bonds when the market rate of interest is
10%. Interest is paid semiannually.
Required: Determine how much cash JKL Company should realize from the bond issue.
Chapter 6 Time Value of Money Concepts
108. MBI Company’s largest computer has a cash selling price of $200,000. A customer wishes to
buy the computer on a lease purchase plan over five years, with the first payment to be made
at the inception of the lease. Interest is at 10%.
Required:
a. Compute the amount of the annual lease payment and the gross amount due (total
payments) under the lease.
b. Compute the amount of interest income earned by MBI for the first year of the lease.
109. Taylor’s tractor-trailer rigs sell for $150,000. A customer wishes to buy a rig on a lease
purchase plan over seven years, with the first payment to be made at the inception of the lease.
Interest is at 12%.
Required:
a. Compute the amount of the annual lease payment and the gross amount (total payments)
due under the lease.
b. Compute the amount of interest income earned by Taylor’s for the first year of the lease.
110. Titan Corporation has a defined benefit pension plan. One of its employees has vested benefits
under the plan, which will pay her $30,000 annually for life starting with the first $30,000
payment on the day she retires at the age of 65. The employee has just reached the age of 45.
Titan consulted standard mortality tables to come up with a life expectancy of 80 for this
employee. The implicit interest rate under the plan is 9%.
Required:
a. What will be the present value of the pension obligation at the time of the employee’s
retirement?
b. What is the present value of the pension obligation at the current time?
111. King Corporation has a defined benefit pension plan. One of its employees has vested benefits
under the plan, which will pay him $40,000 annually for life starting with the first payment of
$40,000 on the day he retires at the age of 65. The employee has just reached the age of 50.
King consulted standard mortality tables to come up with a life expectancy of 80 for this
employee. The implicit interest rate under the plan is 9%.
Required:
a. What will be the present value of the pension obligation at the time of the employee’s
retirement?
b. What is the present value of the pension obligation at the current time?
112. On September 30, 2016, Truckee Garbage leased equipment from a supplier and agreed to pay
$125,000 annually for 15 years beginning September 30, 2017. Generally accepted
accounting principles require that a liability be recorded for this lease agreement for the
present value of scheduled payments. Accordingly, at inception of the lease, Truckee
recorded a $1,214,031 lease liability
Required:
Determine the interest rate implicit in the lease agreement.
113. On June 30, 2016, Gunderson Electronics issued 8% stated rate bonds with a face amount of
$300 million. The bonds mature on June 30, 2036 (20 years). The market rate of interest for
similar bond issues was 10% (5% semiannual rate). Interest is paid semiannually (4%) on
June 30 and December 31, beginning on December 31, 2016.
Required:
a. Determine the price of the bonds on June 30, 2016.
b. Calculate the interest expense Gunderson reports in 2016 for these bonds.
Chapter 6 Time Value of Money Concepts
Chapter 6 Time Value of Money Concepts
Essay
Instructions:
The following answers point out the key phrases that should appear in students’ answers. They are not
intended to be examples of complete student responses. It might be helpful to provide detailed
instructions to students on how brief or in-depth you want their answers to be.
114. Briefly describe the difference between simple interest and compound interest.
115. Explain how you would compute the imputed interest on cash borrowed at 0% interest when
the market rate of interest is 8%.
116. Two banks each have annual CD rates of 12%. Bank A compounds quarterly and Bank B
compounds semiannually. Explain which bank offers the better CD.
Chapter 6 Time Value of Money Concepts
117. Briefly describe the differences between an ordinary annuity, an annuity due, and a deferred
annuity.
118. Prepare a time diagram for the future value of an ordinary annuity with three payments of
$300. Be sure to indicate the periods in which interest is added.
119. Prepare a time diagram for the future value of an annuity due with three payments of $400. Be
sure to indicate the periods in which interest is added.
120. Briefly explain how you would arrive at the monthly payment for a 48-month loan where the
first payment is due one month from the loan date. In your explanation, include the use of
present or future value tables.
121. Provide two examples of the use of present value techniques in accounting.
Chapter 6 Time Value of Money Concepts