Present Value Computations Flashcards
An entity agrees to pay $100,000 in 5 years for a piece of land. No other payments will be made. How is the recorded cost of the land determined?
If future cash flows are required and no reasonable interest rate is included within the payments, the cash flows are recorded at their PV, based on a reasonable interest rate.
To determine the PV of future cash flows, what process should be followed?
To find the PV, take the future cash flows and multiply them by a PV conversion rate that is found in a chart.
In order to find the PV of future cash flows, a PV conversion rate must be found. What are the three things needed to determine the correct conversion rate from a chart?
1) number of time periods of the payments
2) a reasonable interest rate under the circumstances
3) Whether the cash flows are a single amount or an annuity
An entity agrees to pay $100,000 in 5 years for a piece of land. The entity will also pay 3% in interest each year. No other payments will be made. How is the recorded cost of the land determined?
if future cash flows are required and no reasonable interest rate is included with the payments, the cash flows are recorded at their PV, based on the reasonable interest rate. Here, the $100,000 will be sued as the cost of the land if the 3% rate is viewed to be reasonable under the circumstances. If the 3% rate is reasonable, then the PV of the cash flows must be determined.
The interest portion of the future payments is recorded as interest expense. This is true whether the 3% rate is deemed to be reasonable, or some other higher rate is used. If a higher rate is used, the PV will be less than $100,000.
What is an annuity?
What are the two types of annuities?
An annuity is an equal payment made at equal time intervals.
1) ordinary annuity - payments at end of first period
2) annuity due - payments begin at the start of the first period
Land is bought for cash flows of $120,000 to be paid in the future. The PV of these cash flows is $90,000. What does the $90,000 represent and what does the remaining $30,000 represent?
As the PV, $90,000 represents the cost paid for the land and the amount to be capitalized.
The remaining $30,000 is interest to be recognized over the life of the cash flows.
Land is bought for $100,000 to be paid in exactly 5 years. No cash interest is to be paid. A reasonable rate is 10%. The PV conversion rate for the single amount of $1 paid in 5 years @ 10% is .62, and for an ordinary annuity of $1 for 5 years at 10% interest is 3.79.
What is the capitalized cost of the land?
the payment is a single amount, so the conversion rate for a single amount is used.
PV = $100,000 x .62 PV = $62,000
The land will be capitalized at $62,000
Land is bought for $20,000 per year to be paid over 5 years. No cash interest is to be paid. A reasonable rate is 10%. The PV conversion rate for the single amount of $1 paid in 5 years @ 10% is .62, and for an ordinary annuity of $1 for 5 years at 10% interest is 3.79.
What is the capitalized cost of the land?
The payment is an annuity, so the conversion rate for an annuity is used:
PV = $20,000 x 3.79 PV = $75,800
The land will be capitalized at $75,800
Land is bought for $100,000 to be paid in exactly 5 years. Cash interest of 3% is to be paid. A reasonable rate is 10%. The PV conversion rate for the single amount of $1 paid in 5 years @ 10% is .62, and for an ordinary annuity of $1 for 5 years at 10% interest is 3.79.
What is the capitalized cost of the land?
Here, there is a single payment as well as an annuity
Single Amount -
PV = $100,000 x .62
PV = $62,000
Annuity -
PV = $3,000 x 3.79
PV = $11,370
The land will be capitalized at $73,370
