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### 6.8. QUESTIONS

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What is the time value of money? Why should accountants have an understanding of compound interest, annuities, and present value concepts?

Identify three situations in which accounting measures are based on present values. Do these present value applications involve single sums or annuities, or both single sums and annuities? Explain.

What is the nature of interest? Distinguish between "simple interest" and "compound interest."

What are the components of an interest rate? Why is it important for accountants to understand these components?

Presented below are a number of values taken from compound interest tables involving the same number of periods and the same rate of interest. Indicate what each of these four values represents.

6.71008

2.15892

.46319

14.48656

Jose Oliva is considering two investment options for a $1,500 gift he received for graduation. Both investments have 8% annual interest rates. One offers quarterly compounding; the other compounds on a semiannual basis. Which investment should he choose? Why?

Regina Henry deposited $20,000 in a money market certificate that provides interest of 10% compounded quarterly if the amount is maintained for 3 years. How much will Regina Henry have at the end of 3 years?

Will Smith will receive $80,000 on December 31, 2015 (5 years from now) from a trust fund established by his father. Assuming the appropriate interest rate for discounting is 12% (compounded semiannually), what is the present value of this amount today?

What are the primary characteristics of an annuity? Differentiate between an "ordinary annuity" and an "annuity due."

Kehoe, Inc. owes $40,000 to Ritter Company. How much would Kehoe have to pay each year if the debt is retired through four equal payments (made at the end of the year), given an interest rate on the debt of 12%? (Round to two decimal places.)

The Kellys are planning for a retirement home. They estimate they will need $200,000 4 years from now to purchase this home. Assuming an interest rate of 10%, what amount must be deposited at the end of each of the 4 years to fund the home price? (Round to two decimal places.)

Assume the same situation as in Question 11, except that the four equal amounts are deposited at the beginning of the period rather than at the end. In this case, what amount must be deposited at the beginning of each period? (Round to two decimals.)

Explain how the future value of an ordinary annuity interest table is converted to the future value of an annuity due interest table.

Explain how the present value of an ordinary annuity interest table is converted to the present value of an annuity due interest table.

In a book named Treasure, the reader has to figure out where a 2.2 pound, 24 kt gold horse has been buried. If the horse is found, a prize of $25,000 a year for 20 years is provided. The actual cost to the publisher to purchase an annuity to pay for the prize is $245,000. What interest rate (to the nearest percent) was used to determine the amount of the annuity? (Assume end-of-year payments.)

Alexander Enterprises leases property to Hamilton, Inc. Because Hamilton, Inc. is experiencing financial difficulty, Alexander agrees to receive five rents of $20,000 at the end of each year, with the rents deferred 3 years. What is the present value of the five rents discounted at 12%?

Answer the following questions.

On May 1, 2010, Goldberg Company sold some machinery to Newlin Company on an installment contract basis. The contract required five equal annual payments, with the first payment due on May 1, 2010. What present value concept is appropriate for this situation?

On June 1, 2010, Seymour Inc. purchased a new machine that it does not have to pay for until May 1, 2012. The total payment on May 1, 2012, will include both principal and interest. Assuming interest at a 12% rate, the cost of the machine would be the total payment multiplied by what time value of money concept?

Costner Inc. wishes to know how much money it will have available in 5 years if five equal amounts of $35,000 are invested, with the first amount invested immediately. What interest table is appropriate for this situation?

Jane Hoffman invests in a "jumbo" $200,000, 3-year certificate of deposit at First Wisconsin Bank. What table would be used to determine the amount accumulated at the end of 3 years?

Recently Glenda Estes was interested in purchasing a Honda Acura. The salesperson indicated that the price of the car was either $27,600 cash or $6,900 at the end of each of 5 years. Compute the effective interest rate to the nearest percent that Glenda would pay if she chooses to make the five annual payments.

Recently, property/casualty insurance companies have been criticized because they reserve for the total loss as much as 5 years before it may happen. The IRS has joined the debate because they say the full reserve is unfair from a taxation viewpoint. What do you believe is the IRS position?