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Reporting and Interpreting Liabilities Chapter 09 Part 2 – Long-Term Liabilities and Present Value Techniques McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. Long-Term Liabilities Creditors often require the borrower to pledge specific assets as security for the long-term liability. Maturity = 1 year or less Maturity > 1 year Current Liabilities Noncurrent Liabilities Long-Term Notes Payable and Bonds Relatively small debt needs can be filled from single sources. Banks Insurance Companies Pension Plans Long-Term Notes Payable and Bonds Significant debt needs are often filled by issuing bonds to the public. Bonds Cash Present Value Concepts $1,000 invested today at 10%. In 1 year it will be worth $1,100. In 5 years it will be worth $1,610! Money can grow over time, because it can earn interest. Present Value Concepts The growth is a mathematical function of four variables: 1. The value today (present value). 2. The value in the future (future value). 3. The interest rate. 4. The time period. Present Value of a Single Amount The present value of a single amount is the worth to you today of receiving that amount some time in the future. Present Value Future Value Interest compounding periods Today Future Calculating the Present Value of a Single Amount • Need: 1. The Appropriate Interest Rate (i) Use these to determine the PVF$ 2. The number of periods (n) 3. Future Value you wish to determine its present value • Multiply the PVF$ (Present Value Factor of a $) times the future value Calculating the PVF$ and PVFA Present Value Factor for a single amount PVF$ = 1/(1 + i)^n Present Value Factor for An Annuity Formula PVFA = (1-PVF$)/i Present Value of a Single Amount How much do we need to invest today at 10% interest, compounded annually, if we need $1,331 in three years? a. $1,000.00 The required future amount is $1,331. b. $ 990.00 i = 10% & n = 3 years c. $ 751.30 Using the present value of a single amount d. $ 970.00 table, the factor is .7513. $1,331 × .7513 = $1,000 (rounded) Present Values of an Annuity An annuity is a series of consecutive equal periodic payments. Today Present Values of an Annuity What is the value today of a series of payments to be received or paid out in the future? Payment 1 Present Value Today Payment 2 Interest compounding periods Payment 3 Calculating the Present Value of an Annuity • Need: 1. The Appropriate Interest Rate (i) 2. The number of periods (n) 3. Annual payment Use these to determine the PVFA • Multiply the PVFA (Present Value Factor of an Annuity) times the annual payment Calculating the PVF$ and PVFA Present Value Factor for a single amount PVF$ = 1/(1 + i)^n Present Value Factor for An Annuity Formula PVFA = (1-PVF$)/i Present Values of an Annuity What is the present value of receiving $1,000 each year for three years at an interest rate of 10%, compounded annually? a. $3,000.00 b. $2,910.00 The consecutive equal payment amount is $1,000. c. $2,700.00 i = 10% & n = 3 years d. $2,486.90 Using the present value of an annuity table, the factor is 2.4869. $1,000 × 2.4869 = $2,486.90 Try AP9-6 (page 500-501)