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WUSTL ACCT 2610 - Solution to practice problems of Chapter 9-1

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Solution to PP of Chapter 9PP1:a. Calculate PV of the second option:PV = 3000 * PVannuity (I = 8%, n = 4) = 3000 * 3.3121 = 9936.3b. calculate PV of third option:PV = 15,000 * PVss (I = 8%, I=8%, n = 5) = 15,000 *0.6806 = 10209c. The decision rule is to choose the lowest value. So you should pick the second optionas it yields the lowest present value.PP2:PV = 40,000 * PVss (I = 10%, n = 7) = 40,000 * 0.5132 = 20,528 PP3:The present value of the second option is:PV = 35,000 * PV annuity (I = 6%, n=10) = 35,000 * 7.3601 = 257,604Decision rule is to pick the higher one. As the second option gives Bob a higher present value, he should pick up this option.PP4:This problem combines the material of chapter 8 and chapter 9. The first issue we need toaddress is finding the cost of the equipment. Following the historical cost principle we need to record the equipment at its cash equivalent cost at the time of the purchase. Since the 500,000 will only be paid in three years, that amount includes interest which we don’twant to include in the cost of the equipment. What is the cost of the equipment today? In other words, what is the face value of the note we signed? So far, when we dealt with purchasing equipment with notes, the face value of the note was given to us. We did not calculate how much we will need to pay in the future. In this problem, we are given the amount to be paid in the future, and since weknow how to calculate present values, we are asked to calculate the face value of the debt(or the current cost of the equipment). Read more about this issue on pages 510-512 of your textbook. 1. The cost of the equipment will be:500,000*PV-Single amount-(3,10%) = 500,000*0.7513 = 375,650The journal entry would be:Dr: Equipment 375,650Cr: Note payable 375,6502. At the end of the year, we need to record depreciation and interest:- Depreciation:(375,650-75,650)/5 = 60,000Dr: Depreciation expense 60,000Cr: Accumulated depreciation 60,000- Interest:375,650 * 0.1 = 37,565Dr: Interest expense 37,565Cr: Interest Payable 37,5653. The interest expense in 2002, the second year, will be:(375,650+37,565)*0.1 = 41,321.5. This includes interest on the principal as well as on the interest that was compounded in the first year. 4. The interest expense in 2003, the third year, will be:(375,650 + 37,565 + 41,321)*10% = 45454The adjusting entry for recognizing depreciation expense will be the same as the one in 2001.The adjusting entry for recognizing interest expense will be:Dr: Interest Expense 45,454Cr: Interest payable 45,454The entry to recognize payment for the notes payable is:Dr: Notes payable 375,650Dr: Interest payable 124,350Cr. Cash 500,000PP5:APBeg. 465M? 7 BEnd 500M? = 465m + 7b – 500m =


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WUSTL ACCT 2610 - Solution to practice problems of Chapter 9-1

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