Time Value of Money Duncan 1074 Accounting 2200 December 2014 1 Interest a Compounded Interest interest earned on increasing principle principle previously earned interest i Compounding the frequency with which interest is added to the principle ii Discounting finding how much a future value is worth today iii 4 Situations iv Table Factors n of periods on left i interest rate on top FV of Lump Sum PV of Lump Sum FV of an Annuity PV of an Annuity 1 Adjustments 1 2 3 4 2 3 i rate compounds per year n of periods of compounds per year FVF 1 i n PVF 1 1 i n b Simple Interest PRT I interest only earned on original amount invested 2 Lump Sum a PVF and FVF are reciprocals 3 Future Value of a Lump Sum a How much will today s money be worth in some future time b 4 Present Value of a Lump Sum a How much is the future s money worth today b 5 Annuity a Annuity series of equal payments received paid with consistent time in between i Ordinary payment at end of period 1 Factors are as found in table ii Annuity Due payment at beginning of period 1 Factors are multiplied by 1 interest rate used in table b c Payment value of each individual payment PVAF and FVAF are not reciprocals 6 Future Value of an Annuity a How much are equal payments received at consistent interval worth at some point in the future b 7 Prevent Value of an Annuity a How much are equal payments received at consistent intervals worth today b 8 Apples to Apples a It is easiest to find PV of each alternatives to compare values Debt Financing Duncan 1074 Accounting 2200 December 2014 1 Long Term Notes Payable Liabilities with duration greater than 1 year a b Mortgage loan in exchange of property made by pledging assets of collateral i Typically paid monthly interest repayment of principle ii Initially recorded at face value PV c Amortization Table table which assists in finding amount interest and amount repayment of principle in each payment Date Purchase Payments Payment Given Determined w TVoM Interest 12 Repayment of Principle Payment I RoP Loan Balance Face Value X X RoP i For last year s payment make payment on principle equal balance and force out interest 2 Mortgage a Initially recorded at face value i CF Financing Inflow x x Subsequent Payments require amortization work BS Aup Lup Mortgage Payable IS N A Cash X X i IS Eup NIdown Interest Expense Mortgage Payable x x Interest Paid sum interest column in amortization table Total Reduction of Principle sum RoP column or subtract current Loan Balance from Face Value BS Adown Ldown Edown X Y X Y Cash CF IntExp Operating Outflow MortPay Financing Outlfow 3 Lease Lease a contract that specifies the terms under which the owner of an asset agrees to transfer the right to use the asset to another party type dictated by FASB Operating or Capital i Operating Lease Lessee assumes no risk of ownership 1 2 3 Payments are rent expense End of contract lessee has no rights Preferred b c don t have to record liabilities better financing positioning off balance sheet financing ii Capital Lease lessee assumes purchase of asset 1 Includes related liability and depreciation Lessee party granted the right to use property under terms of a lease Lessor owner of a property that is rented leaded to another party 4 Operating Lease No initial journal entry Subsequent Payments x x Rent Expense Cash 5 Capital Lease a Leased asset and liability must appear on balance sheet at PV X X X A B X A B i Asset depreciates over time ii Liability must be amortized iii No residual value Leased Liability Leased Asset Purchase x x Payment x x End of Year Adjustment x x Interest Expense Leased Liability Cash 6 Ratios a Debt to Equity Depreciation Expense C Accumulated Depreciation C i of fund from creditors vs stockholders provides measure of protection if cannot pay insolvent ii High DTE High risk to creditors High interest rate b Times Interest Earned Shows company s ability to pay interest payments as they come due i ii High TIE better ability to pay when due margin of safety provided to creditors b c d a b c a b b c d Equity Financing Duncan 1074 Accounting 2200 December 2014 1 Financing 2 Equity a a Debt Financing loan repayment liable for amount of loan i Relationship with creditors ends at completion of loan b Equity Financing money from investors stockholders don t have to repay i Rewarded by company s success Contributed Capital amounts owners have contributed through purchase of stock Capital Stock Preferred and Common accounted for in same ways i Preferred Stock 1 Dividend preference must be paid in full before common stockholders get any if dividend paid a Usually cumulative must be paid both current and prior years dividends in arrears unpaid dividends before common stockholders get anything If unpaid disclosed in FS as dividends in arrears not liability b 2 Dividend is a fixed percentage 3 Typically do not have voting rights ii Common Stock 1 Voting rights BOD significant managerial activities 2 Dividend rates determined by BOD not set 3 Get dividends only after preferred stockholders have been paid in full b Retained Earnings net income earned by a company not paid out as dividends 3 Stock a Par Value monetary amount signed to each type of stock used only for accounting not at all related to market value i Used to record transaction stock account recorded at par ii Excess sale over par goes to Paid In Capital account 1 Equity account when PIC Preferred PIC Common PIC Treasury later discussed b Sale of Stock i Transactions involving company s own stock never affect NI ii CF Financing Inflow x x IS N A Cash BS Aup Eup Common Stock PIC Common X Y X Y iii Above example reflects a sale above par value same process for preferred stock c Shares Issued Shares total number of shares sold to public i Authorized Shares total number of share of stock that company is allowed to sell to the public ii iii Outstanding Shares total number of shares in hands of shareholders iv Issued Shares Outstanding Shares number of shares reacquired by company 1 Called Treasury Stock 4 Treasury Stock a Properties i Contraequity ii No voting rights no right to receive dividend iii Record at reacquisition cost not par value iv No gains losses ever recorded v IS N A BS Adown Edown CF Financing Outflow b Why i Reduces shares outstanding increase market value ii Market price may be low iii Remove shares to avoid hostile takeover iv To use in employee stock options v Give cash back to existing shareholders vi Increase reported earnings