1460T_c06.qxd12/2/0509:28 am Page293 EQA Exercises·293 Instructions On the basis of the information above,determine the present value of the pension obligation (liability). (L0 5,E6-15 (Investment Decision)Andrew Bogut just received a signing bonus of $1,000,000.His plan is to 6) invest this payment in a fund that will earn 8%,compounded annually. Instructions (a)If Bogut plans to establish the AB Foundation once the fund grows to $1,999,000,how many years until he can establish the foundation? (b)Instead of investing the entire $1,000,000,Bogut invests $300,000 today and plans to make 9 equal annual investments into the fund beginning one year from today.What amount should the pay- ments be if Bogut plans to establish the $1,999,000 foundation at the end of 9 years? (L0 6,E6-16 (Retirement of Debt)Jesper Parnevik borrowed $70,000 on March 1,2005.This amount plus ac- 7) crued interest at 12%compounded semiannually is to be repaid March 1,2015.To retire this debt,Jesper plans to contribute to a debt retirement fund five equal amounts starting on March 1,2010,and for the next 4 years.The fund is expected to earn 10%per annum Instructions How much must be contributed each year by Jesper Parnevik to provide a fund sufficient to retire the debt on March 1,2015? (L0 7)E6-17 (Computation of Amount of Rentals)Your client,Ron Santo Leasing Company,is preparing a contract to lease a machine to Souvenirs Corporation for a period of 25 years.Santo has an investment cost of $365,755 in the machine,which has a useful life of 25 years and no salvage value at the end of that time.Your client is interested in earning an 11%return on its investment and has agreed to accept 25 equal rental payments at the end of each of the next 25 years Instructions You are requested to provide Santo with the amount of each of the 25 rental payments that will yield an 11%return on investment. (L0 5,E6-18 (Least Costly Payoff)Assume that Sonic Foundry Corporation has a contractual debt out- 7) standing.Sonic has available two means of settlement:It can either make immediate payment of $2,600,000, or it can make annual payments of $300,000 for 15 years,each payment due on the last day of the year. Instructions Which method of payment do you recommend,assuming an expected effective interest rate of 8%dur- ing the future period? (Lo 5,E6-19 (Least Costly Payoff)Assuming the same facts as those in E6-18 except that the payments 7) must begin now and be made on the first day of each of the 15 years,what payment method would you recommend? (L0 9)E6-20 (Expected Cash Flows)For each of the following,determine the expected cash flows. Probability Cash Flow Estimate Assessment (a) $3,800 20% 6,300 50% 7,500 30% (b) $5,400 30% 7,200 50% 8.400 20% (c) s(1,000) 10% 2000 80% 5,000 10% (L0 9)E6-21 (Expected Cash Flows and Present Value)Andrew Kelly is trying to determine the amount to set aside so that he will have enough money on hand in 2 years to overhaul the engine on his vintage used car.While there is some uncertainty about the cost of engine overhauls in 2 years,by conducting some research online,Andrew has developed the following estimates. Engine Overhaul Probability Estimated Cash Outflow Assessment $200 10% 450 30% 550 50% 750 10%
Exercises • 293 Instructions On the basis of the information above, determine the present value of the pension obligation (liability). E6-15 (Investment Decision) Andrew Bogut just received a signing bonus of $1,000,000. His plan is to invest this payment in a fund that will earn 8%, compounded annually. Instructions (a) If Bogut plans to establish the AB Foundation once the fund grows to $1,999,000, how many years until he can establish the foundation? (b) Instead of investing the entire $1,000,000, Bogut invests $300,000 today and plans to make 9 equal annual investments into the fund beginning one year from today. What amount should the payments be if Bogut plans to establish the $1,999,000 foundation at the end of 9 years? E6-16 (Retirement of Debt) Jesper Parnevik borrowed $70,000 on March 1, 2005. This amount plus accrued interest at 12% compounded semiannually is to be repaid March 1, 2015. To retire this debt, Jesper plans to contribute to a debt retirement fund five equal amounts starting on March 1, 2010, and for the next 4 years. The fund is expected to earn 10% per annum. Instructions How much must be contributed each year by Jesper Parnevik to provide a fund sufficient to retire the debt on March 1, 2015? E6-17 (Computation of Amount of Rentals) Your client, Ron Santo Leasing Company, is preparing a contract to lease a machine to Souvenirs Corporation for a period of 25 years. Santo has an investment cost of $365,755 in the machine, which has a useful life of 25 years and no salvage value at the end of that time. Your client is interested in earning an 11% return on its investment and has agreed to accept 25 equal rental payments at the end of each of the next 25 years. Instructions You are requested to provide Santo with the amount of each of the 25 rental payments that will yield an 11% return on investment. E6-18 (Least Costly Payoff) Assume that Sonic Foundry Corporation has a contractual debt outstanding. Sonic has available two means of settlement: It can either make immediate payment of $2,600,000, or it can make annual payments of $300,000 for 15 years, each payment due on the last day of the year. Instructions Which method of payment do you recommend, assuming an expected effective interest rate of 8% during the future period? E6-19 (Least Costly Payoff) Assuming the same facts as those in E6-18 except that the payments must begin now and be made on the first day of each of the 15 years, what payment method would you recommend? E6-20 (Expected Cash Flows) For each of the following, determine the expected cash flows. Probability Cash Flow Estimate Assessment (a) $ 3,800 20% 6,300 50% 7,500 30% (b) $ 5,400 30% 7,200 50% 8,400 20% (c) $(1,000) 10% 2,000 80% 5,000 10% E6-21 (Expected Cash Flows and Present Value) Andrew Kelly is trying to determine the amount to set aside so that he will have enough money on hand in 2 years to overhaul the engine on his vintage used car. While there is some uncertainty about the cost of engine overhauls in 2 years, by conducting some research online, Andrew has developed the following estimates. Engine Overhaul Probability Estimated Cash Outflow Assessment $200 10% 450 30% 550 50% 750 10% (L0 5, 6) (L0 6, 7) (L0 7) (L0 5, 7) (L0 5, 7) (L0 9) (L0 9) 1460T_c06.qxd 12/2/05 09:28 am Page 293
1460T_c06.qxd12/2/0509:28 am Page294 EQA 294.Chapter 6 Accounting and the Time Value of Money Instructions How much should Andrew Kelly deposit today in an account earning 6%,compounded annually,so that he will have enough money on hand in 2 years to pay for the overhaul? (L0 10)E6-22 (Determine Interest Rate)Reba McEntire wishes to invest $19,000 on July 1,2007,and have it accumulate to $49,000 by July 1,2017. Instructions Use a financial calculator to determine at what exact annual rate of interest Reba must invest the $19,000. (L0 10)*E6-23 (Determine Interest Rate)On July 17,2006,Tim McGraw borrowed $42,000 from his grand- father to open a clothing store.Starting July 17,2007,Tim has to make ten equal annual payments of $6,500 each to repay the loan. Instructions Use a financial calculator to determine what interest rate Tim is paying. (L0 10)*E6-24 (Determine Interest Rate)As the purchaser of a new house,Patty Loveless has signed a mort- gage note to pay the Memphis National Bank and Trust Co.$14,000 every 6 months for 20 years,at the end of which time she will own the house.At the date the mortgage is signed the purchase price was $198,000,and a down payment of $20,000 was made.The first payment will be made 6 months after the date the mortgage is signed. Instructions Using a financial calculator,compute the exact rate of interest earned on the mortgage by the bank. See the book's website,www.wiley.com/college/kieso,for Additional Exercises. PROBLEMS ⊕ (Interest rates are per annum unless otherwise indicated.) (L05, P6-1 (Various Time Value Situations)Answer each of these unrelated questions. 6,7) (a)On January 1,2007,Aaron Brown Corporation sold a building that cost $250,000 and that had accu- mulated depreciation of $100,000 on the date of sale.Brown received as consideration a $275,000 noninterest-bearing note due on January 1,2010.There was no established exchange price for the building,and the note had no ready market.The prevailing rate of interest for a note of this type on January 1,2007,was 9%.At what amount should the gain from the sale of the building be reported? (b) On January 1,2007,Aaron Brown Corporation purchased 200 of the $1,000 face value,9%,10-year bonds of Walters Inc.The bonds mature on January 1,2017,and pay interest annually beginning January 1,2008.Brown purchased the bonds to yield 11%.How much did Brown pay for the bonds? (c)Aaron Brown Corporation bought a new machine and agreed to pay for it in equal annual in- stallments of $4,000 at the end of each of the next 10 years.Assuming that a prevailing interest rate of 8%applies to this contract,how much should Brown record as the cost of the machine? (d)Aaron Brown Corporation purchased a special tractor on December 31,2007.The purchase agree- ment stipulated that Brown should pay $20,000 at the time of purchase and $5,000 at the end of each of the next 8 years.The tractor should be recorded on December 31,2007,at what amount, assuming an appropriate interest rate of 12%? (e) Aaron Brown Corporation wants to withdraw $100,000(including principal)from an investment fund at the end of each year for 9 years.What should be the required initial investment at the be ginning of the first year if the fund earns 11%? (L05, P6-2 (Various Time Value Situations)Using the appropriate interest table,provide the solution to each 6,7) of the following four questions by computing the unknowns (a)What is the amount of the payments that Tom Brokaw must make at the end of each of 8 years to accumulate a fund of $70,000 by the end of the eighth year,if the fund earns 8%interest,com- pounded annually? (b)Anderson Cooper is 40 years old today and he wishes to accumulate $500,000 by his sixty-fifth birthday so he can retire to his summer place on Lake Hopatcong.He wishes to accumulate this amount by making equal deposits on his fortieth through his sixty-fourth birthdays.What annual deposit must Anderson make if the fund will earn 12%interest compounded annually?
Instructions How much should Andrew Kelly deposit today in an account earning 6%, compounded annually, so that he will have enough money on hand in 2 years to pay for the overhaul? *E6-22 (Determine Interest Rate) Reba McEntire wishes to invest $19,000 on July 1, 2007, and have it accumulate to $49,000 by July 1, 2017. Instructions Use a financial calculator to determine at what exact annual rate of interest Reba must invest the $19,000. *E6-23 (Determine Interest Rate) On July 17, 2006, Tim McGraw borrowed $42,000 from his grandfather to open a clothing store. Starting July 17, 2007, Tim has to make ten equal annual payments of $6,500 each to repay the loan. Instructions Use a financial calculator to determine what interest rate Tim is paying. *E6-24 (Determine Interest Rate) As the purchaser of a new house, Patty Loveless has signed a mortgage note to pay the Memphis National Bank and Trust Co. $14,000 every 6 months for 20 years, at the end of which time she will own the house. At the date the mortgage is signed the purchase price was $198,000, and a down payment of $20,000 was made. The first payment will be made 6 months after the date the mortgage is signed. Instructions Using a financial calculator, compute the exact rate of interest earned on the mortgage by the bank. PROBLEMS (Interest rates are per annum unless otherwise indicated.) P6-1 (Various Time Value Situations) Answer each of these unrelated questions. (a) On January 1, 2007, Aaron Brown Corporation sold a building that cost $250,000 and that had accumulated depreciation of $100,000 on the date of sale. Brown received as consideration a $275,000 noninterest-bearing note due on January 1, 2010. There was no established exchange price for the building, and the note had no ready market. The prevailing rate of interest for a note of this type on January 1, 2007, was 9%. At what amount should the gain from the sale of the building be reported? (b) On January 1, 2007, Aaron Brown Corporation purchased 200 of the $1,000 face value, 9%, 10-year bonds of Walters Inc. The bonds mature on January 1, 2017, and pay interest annually beginning January 1, 2008. Brown purchased the bonds to yield 11%. How much did Brown pay for the bonds? (c) Aaron Brown Corporation bought a new machine and agreed to pay for it in equal annual installments of $4,000 at the end of each of the next 10 years. Assuming that a prevailing interest rate of 8% applies to this contract, how much should Brown record as the cost of the machine? (d) Aaron Brown Corporation purchased a special tractor on December 31, 2007. The purchase agreement stipulated that Brown should pay $20,000 at the time of purchase and $5,000 at the end of each of the next 8 years. The tractor should be recorded on December 31, 2007, at what amount, assuming an appropriate interest rate of 12%? (e) Aaron Brown Corporation wants to withdraw $100,000 (including principal) from an investment fund at the end of each year for 9 years. What should be the required initial investment at the beginning of the first year if the fund earns 11%? P6-2 (Various Time Value Situations) Using the appropriate interest table, provide the solution to each of the following four questions by computing the unknowns. (a) What is the amount of the payments that Tom Brokaw must make at the end of each of 8 years to accumulate a fund of $70,000 by the end of the eighth year, if the fund earns 8% interest, compounded annually? (b) Anderson Cooper is 40 years old today and he wishes to accumulate $500,000 by his sixty-fifth birthday so he can retire to his summer place on Lake Hopatcong. He wishes to accumulate this amount by making equal deposits on his fortieth through his sixty-fourth birthdays. What annual deposit must Anderson make if the fund will earn 12% interest compounded annually? 294 • Chapter 6 Accounting and the Time Value of Money (L0 5, 6, 7) (L0 10) (L0 10) (L0 10) (L0 5, 6, 7) wi el moc. y c/ ollege/kieso See the book’s website, www.wiley.com/college/kieso, for Additional Exercises. 1460T_c06.qxd 12/2/05 09:28 am Page 294
1460T_c06.qxd1/10/0602:26 am Page295 EQA Problems·295 (c)Jane Pauley has $20,000 to invest today at 9%to pay a debt of $56,253.How many years will it take her to accumulate enough to liquidate the debt? (d)Maria Shriver has a $27,600 debt that she wishes to repay 4 years from today;she has $18,181 that she intends to invest for the 4 years.What rate of interest will she need to earn annually in order to accumulate enough to pay the debt? (L05, P6-3 (Analysis of Alternatives)Assume that Wal-Mart,Inc.has decided to surface and maintain for 6,7) 10 years a vacant lot next to one of its discount-retail outlets to serve as a parking lot for customers.Man- agement is considering the following bids involving two different qualities of surfacing for a parking area of 12,000 square yards. Bid A:A surface that costs $5.25 per square yard to install.This surface will have to be replaced at the end of 5 years.The annual maintenance cost on this surface is estimated at 20 cents per square yard for each year except the last year of its service.The replacement surface will be similar to the initial surface. Bid B:A surface that costs $9.50 per square yard to install.This surface has a probable useful life of 10 years and will require annual maintenance in each year except the last year,at an estimated cost of 9 cents per square yard. Instructions Prepare computations showing which bid should be accepted by Wal-Mart,Inc.You may assume that the cost of capital is 9%,that the annual maintenance expenditures are incurred at the end of each year,and that prices are not expected to change during the next 10 years. (L06, P6-4 (Evaluating Payment Alternatives)Terry O'Malley has just learned he has won a $900,000 prize 7) in the lottery.The lottery has given him two options for receiving the payments:(1)If Terry takes all the money today,the state and federal governments will deduct taxes at a rate of 46%immediately. (2)Alternatively,the lottery offers Terry a payout of 20 equal payments of $62,000 with the first payment occurring when Terry turns in the winning ticket.Terry will be taxed on each of these payments at a rate of25%. Instructions Assuming Terry can earn an 8%rate of return(compounded annually)on any money invested during this period,which pay-out option should he choose? (L05, P6-5 (Analysis of Alternatives)Sally Brown died,leaving to her husband Linus an insurance policy 6,7) contract that provides that the beneficiary (Linus)can choose any one of the following four options. (a)$55,000 immediate cash. (b)$3,700 every 3 months payable at the end of each quarter for 5 years. (c) $18,000 immediate cash and $1,600 every 3 months for 10 years,payable at the beginning of each 3-month period. (d)$4,000 every 3 months for 3 years and $1,200 each quarter for the following 25 quarters,all pay- ments payable at the end of each quarter. Instructions If money is worth 2%%per quarter,compounded quarterly,which option would you recommend that Linus exercise? (L0 8)P6-6 (Purchase Price of a Business)During the past year,Nicole Bobek planted a new vineyard on 150 acres of land that she leases for $27,000 a year.She has asked you as her accountant to assist her in determining the value of her vineyard operation The vineyard will bear no grapes for the first 5 years (1-5).In the next 5 years (6-10),Nicole estimates that the vines will bear grapes that can be sold for $60,000 each year.For the next 20 years(11-30)she ex- pects the harvest will provide annual revenues of $100,000.But during the last 10 years (31-40)of the vineyard's life,she estimates that revenues will decline to $80,000 per year. During the first 5 years the annual cost of pruning,fertilizing,and caring for the vineyard is estimated at $9,000;during the years of production,6-40,these costs will rise to $10,000 per year.The relevant mar- ket rate of interest for the entire period is 12%.Assume that all receipts and payments are made at the end of each year. Instructions Dick Button has offered to buy Nicole's vineyard business by assuming the 40-year lease.On the basis of the current value of the business,what is the minimum price Nicole should accept? (L0 5,P6-7 (Time Value Concepts Applied to Solve Business Problems)Answer the following questions 6,7)related to Derek Lee Inc
(c) Jane Pauley has $20,000 to invest today at 9% to pay a debt of $56,253. How many years will it take her to accumulate enough to liquidate the debt? (d) Maria Shriver has a $27,600 debt that she wishes to repay 4 years from today; she has $18,181 that she intends to invest for the 4 years. What rate of interest will she need to earn annually in order to accumulate enough to pay the debt? P6-3 (Analysis of Alternatives) Assume that Wal-Mart, Inc. has decided to surface and maintain for 10 years a vacant lot next to one of its discount-retail outlets to serve as a parking lot for customers. Management is considering the following bids involving two different qualities of surfacing for a parking area of 12,000 square yards. Bid A: A surface that costs $5.25 per square yard to install. This surface will have to be replaced at the end of 5 years. The annual maintenance cost on this surface is estimated at 20 cents per square yard for each year except the last year of its service. The replacement surface will be similar to the initial surface. Bid B: A surface that costs $9.50 per square yard to install. This surface has a probable useful life of 10 years and will require annual maintenance in each year except the last year, at an estimated cost of 9 cents per square yard. Instructions Prepare computations showing which bid should be accepted by Wal-Mart, Inc. You may assume that the cost of capital is 9%, that the annual maintenance expenditures are incurred at the end of each year, and that prices are not expected to change during the next 10 years. P6-4 (Evaluating Payment Alternatives) Terry O’Malley has just learned he has won a $900,000 prize in the lottery. The lottery has given him two options for receiving the payments: (1) If Terry takes all the money today, the state and federal governments will deduct taxes at a rate of 46% immediately. (2) Alternatively, the lottery offers Terry a payout of 20 equal payments of $62,000 with the first payment occurring when Terry turns in the winning ticket. Terry will be taxed on each of these payments at a rate of 25%. Instructions Assuming Terry can earn an 8% rate of return (compounded annually) on any money invested during this period, which pay-out option should he choose? P6-5 (Analysis of Alternatives) Sally Brown died, leaving to her husband Linus an insurance policy contract that provides that the beneficiary (Linus) can choose any one of the following four options. (a) $55,000 immediate cash. (b) $3,700 every 3 months payable at the end of each quarter for 5 years. (c) $18,000 immediate cash and $1,600 every 3 months for 10 years, payable at the beginning of each 3-month period. (d) $4,000 every 3 months for 3 years and $1,200 each quarter for the following 25 quarters, all payments payable at the end of each quarter. Instructions If money is worth 21 ⁄2% per quarter, compounded quarterly, which option would you recommend that Linus exercise? P6-6 (Purchase Price of a Business) During the past year, Nicole Bobek planted a new vineyard on 150 acres of land that she leases for $27,000 a year. She has asked you as her accountant to assist her in determining the value of her vineyard operation. The vineyard will bear no grapes for the first 5 years (1–5). In the next 5 years (6–10), Nicole estimates that the vines will bear grapes that can be sold for $60,000 each year. For the next 20 years (11–30) she expects the harvest will provide annual revenues of $100,000. But during the last 10 years (31–40) of the vineyard’s life, she estimates that revenues will decline to $80,000 per year. During the first 5 years the annual cost of pruning, fertilizing, and caring for the vineyard is estimated at $9,000; during the years of production, 6–40, these costs will rise to $10,000 per year. The relevant market rate of interest for the entire period is 12%. Assume that all receipts and payments are made at the end of each year. Instructions Dick Button has offered to buy Nicole’s vineyard business by assuming the 40-year lease. On the basis of the current value of the business, what is the minimum price Nicole should accept? P6-7 (Time Value Concepts Applied to Solve Business Problems) Answer the following questions related to Derek Lee Inc. Problems • 295 (L0 5, 6, 7) (L0 6, 7) (L0 5, 6, 7) (L0 8) (L0 5, 6, 7) 1460T_c06.qxd 1/10/06 02:26 am Page 295
1460T_c06.qxd1/10/0602:26 am Page296 EQA 296 Chapter 6 Accounting and the Time Value of Money (a)Derek Lee Inc.has $572,000 to invest.The company is trying to decide between two alternative uses of the funds.One alternative provides $80,000 at the end of each year for 12 years,and the other is to receive a single lump sum payment of $1,900,000 at the end of the 12 years.Which al- ternative should Lee select?Assume the interest rate is constant over the entire investment. (b) Derek Lee Inc.has completed the purchase of new Dell computers.The fair market value of the equipment is $824,150.The purchase agreement specifies an immediate down payment of $200,000 and semiannual payments of $76,952 beginning at the end of 6 months for 5 years.What is the interest rate,to the nearest percent,used in discounting this purchase transaction? (c) Derek Lee Inc.loans money to John Kruk Corporation in the amount of $600,000.Lee accepts an 8%note due in 7 years with interest payable semiannually.After 2 years(and receipt of interest for 2 years),Lee needs money and therefore sells the note to Chicago National Bank,which demands interest on the note of 10%compounded semiannually.What is the amount Lee will receive on the sale of the note? (d)Derek Lee Inc.wishes to accumulate $1,300,000 by December 31,2017,to retire bonds outstand- ing.The company deposits $300,000 on December 31,2007,which will earn interest at 10%com- pounded quarterly,to help in the retirement of this debt.In addition,the company wants to know how much should be deposited at the end of each quarter for 10 years to ensure that $1,300,000 is available at the end of 2017.(The quarterly deposits will also earn at a rate of 10%,compounded quarterly.)(Round to even dollars.) (L0 6,P6-8 (Analysis of Alternatives)Homer Simpson Inc.,a manufacturer of steel school lockers,plans to 7) purchase a new punch press for use in its manufacturing process.After contacting the appropriate ven- dors,the purchasing department received differing terms and options from each vendor.The Engineer- ing Department has determined that each vendor's punch press is substantially identical and each has a useful life of 20 years.In addition,Engineering has estimated that required year-end maintenance costs will be $1,000 per year for the first 5 years,$2,000 per year for the next 10 years,and $3,000 per year for the last 5 years.Following is each vendor's sale package. Vendor A:$45,000 cash at time of delivery and 10 year-end payments of $15,000 each.Vendor A offers all its customers the right to purchase at the time of sale a separate 20-year maintenance service contract, under which Vendor A will perform all year-end maintenance at a one-time initial cost of $10,000. ⊕ Vendor B:Forty seminannual payments of $8,000 each,with the first installment due upon delivery. Vendor B will perform all year-end maintenance for the next 20 years at no extra charge Vendor C:Full cash price of $125,000 will be due upon delivery. Instructions Assuming that both Vendor A and B will be able to perform the required year-end maintenance,that Simpson's cost of funds is 10%,and the machine will be purchased on January 1,from which vendor should the press be purchased? (L05, P6-9 (Analysis of Business Problems)Jean-Luc is a financial executive with Starship Enterprises 6,7) Although Jean-Luc has not had any formal training in finance or accounting,he has a "good sense"for numbers and has helped the company grow from a very small company($500,000 sales)to a large oper- ation($45 million in sales).With the business growing steadily,however,the company needs to make a number of difficult financial decisions in which Jean-Luc feels a little "over his head."He therefore has decided to hire a new employee with"numbers"expertise to help him.As a basis for determining whom to employ,he has decided to ask each prospective employee to prepare answers to questions relating to the following situations he has encountered recently.Here are the questions. (a)In 2005,Starship Enterprises negotiated and closed a long-term lease contract for newly con- structed truck terminals and freight storage facilities.The buildings were constructed on land owned by the company.On January 1,2006,Starship took possession of the leased property.The 20-year lease is effective for the period January 1,2006,through December 31,2025.Advance rental payments of $800,000 are payable to the lessor (owner of facilities)on January 1 of each of the first 10 years of the lease term.Advance payments of $300,000 are due on January 1 for each of the last 10 years of the lease term.Starship has an option to purchase all the leased facilities for $1 on December 31,2025.At the time the lease was negotiated,the fair market value of the truck terminals and freight storage facilities was approximately $7,200,000.If the company had borrowed the money to purchase the facilities,it would have had to pay 10%interest.Should the company have purchased rather than leased the facilities? (b)Last year the company exchanged a piece of land for a non-interest-bearing note.The note is to be paid at the rate of $12,000 per year for 9 years,beginning one year from the date of disposal of the land.An appropriate rate of interest for the note was 11%.At the time the land was origi- nally purchased,it cost $90,000.What is the fair value of the note?
(a) Derek Lee Inc. has $572,000 to invest. The company is trying to decide between two alternative uses of the funds. One alternative provides $80,000 at the end of each year for 12 years, and the other is to receive a single lump sum payment of $1,900,000 at the end of the 12 years. Which alternative should Lee select? Assume the interest rate is constant over the entire investment. (b) Derek Lee Inc. has completed the purchase of new Dell computers. The fair market value of the equipment is $824,150. The purchase agreement specifies an immediate down payment of $200,000 and semiannual payments of $76,952 beginning at the end of 6 months for 5 years. What is the interest rate, to the nearest percent, used in discounting this purchase transaction? (c) Derek Lee Inc. loans money to John Kruk Corporation in the amount of $600,000. Lee accepts an 8% note due in 7 years with interest payable semiannually. After 2 years (and receipt of interest for 2 years), Lee needs money and therefore sells the note to Chicago National Bank, which demands interest on the note of 10% compounded semiannually. What is the amount Lee will receive on the sale of the note? (d) Derek Lee Inc. wishes to accumulate $1,300,000 by December 31, 2017, to retire bonds outstanding. The company deposits $300,000 on December 31, 2007, which will earn interest at 10% compounded quarterly, to help in the retirement of this debt. In addition, the company wants to know how much should be deposited at the end of each quarter for 10 years to ensure that $1,300,000 is available at the end of 2017. (The quarterly deposits will also earn at a rate of 10%, compounded quarterly.) (Round to even dollars.) P6-8 (Analysis of Alternatives) Homer Simpson Inc., a manufacturer of steel school lockers, plans to purchase a new punch press for use in its manufacturing process. After contacting the appropriate vendors, the purchasing department received differing terms and options from each vendor. The Engineering Department has determined that each vendor’s punch press is substantially identical and each has a useful life of 20 years. In addition, Engineering has estimated that required year-end maintenance costs will be $1,000 per year for the first 5 years, $2,000 per year for the next 10 years, and $3,000 per year for the last 5 years. Following is each vendor’s sale package. Vendor A: $45,000 cash at time of delivery and 10 year-end payments of $15,000 each. Vendor A offers all its customers the right to purchase at the time of sale a separate 20-year maintenance service contract, under which Vendor A will perform all year-end maintenance at a one-time initial cost of $10,000. Vendor B: Forty seminannual payments of $8,000 each, with the first installment due upon delivery. Vendor B will perform all year-end maintenance for the next 20 years at no extra charge. Vendor C: Full cash price of $125,000 will be due upon delivery. Instructions Assuming that both Vendor A and B will be able to perform the required year-end maintenance, that Simpson’s cost of funds is 10%, and the machine will be purchased on January 1, from which vendor should the press be purchased? P6-9 (Analysis of Business Problems) Jean-Luc is a financial executive with Starship Enterprises. Although Jean-Luc has not had any formal training in finance or accounting, he has a “good sense” for numbers and has helped the company grow from a very small company ($500,000 sales) to a large operation ($45 million in sales). With the business growing steadily, however, the company needs to make a number of difficult financial decisions in which Jean-Luc feels a little “over his head.” He therefore has decided to hire a new employee with “numbers” expertise to help him. As a basis for determining whom to employ, he has decided to ask each prospective employee to prepare answers to questions relating to the following situations he has encountered recently. Here are the questions. (a) In 2005, Starship Enterprises negotiated and closed a long-term lease contract for newly constructed truck terminals and freight storage facilities. The buildings were constructed on land owned by the company. On January 1, 2006, Starship took possession of the leased property. The 20-year lease is effective for the period January 1, 2006, through December 31, 2025. Advance rental payments of $800,000 are payable to the lessor (owner of facilities) on January 1 of each of the first 10 years of the lease term. Advance payments of $300,000 are due on January 1 for each of the last 10 years of the lease term. Starship has an option to purchase all the leased facilities for $1 on December 31, 2025. At the time the lease was negotiated, the fair market value of the truck terminals and freight storage facilities was approximately $7,200,000. If the company had borrowed the money to purchase the facilities, it would have had to pay 10% interest. Should the company have purchased rather than leased the facilities? (b) Last year the company exchanged a piece of land for a non-interest-bearing note. The note is to be paid at the rate of $12,000 per year for 9 years, beginning one year from the date of disposal of the land. An appropriate rate of interest for the note was 11%. At the time the land was originally purchased, it cost $90,000. What is the fair value of the note? 296 • Chapter 6 Accounting and the Time Value of Money (L0 6, 7) (L0 5, 6, 7) 1460T_c06.qxd 1/10/06 02:26 am Page 296