A manufacturing company purchased electrical services for the next 5 yearsto be paid for with $70,000 now. The service after 5 years will be $15,000 peryear beginning with the sixth year. After 2 years service the company, havingsurplus profits, requested to pay for another 5 years service in advance. If theelectrical company elected to accept payment in advance, what would eachcompany set as a fair settlement to be paid if (a) the electrical company con-sidered 15% compounded annually as a fair return, and (b) the manufactur-ing company considered 12% a fair return?40.

Answered: . A manufacturing company purchased…

Intermediate Accounting: Reporting And Analysis

3rd Edition

ISBN:9781337788281

Author:James M. Wahlen, Jefferson P. Jones, Donald Pagach

Publisher:James M. Wahlen, Jefferson P. Jones, Donald Pagach

Chapter17: Advanced Issues In Revenue Recognition

Section: Chapter Questions

Problem 7C: On January 1, 2019, Mopps Corp. agrees to provide Conklin Company 3 years of cleaning and janitorial...

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Question

A manufacturing company purchased electrical services for the next 5 years
to be paid for with $70,000 now. The service after 5 years will be $15,000 per
year beginning with the sixth year. After 2 years service the company, having
surplus profits, requested to pay for another 5 years service in advance. If the
electrical company elected to accept payment in advance, what would each
company set as a fair settlement to be paid if (a) the electrical company con-
sidered 15% compounded annually as a fair return, and (b) the manufactur-
ing company considered 12% a fair return?
40.

Expert Solution

Step 1

The current value of a future sum of money or stream of cash flows with a constant rate of return is the present value of that sum or stream of cash flows (PV). The present value of future cash flows is reduced by the discount rate; the higher the discount rate, the lower the present value of future cash flows. Choosing the appropriate discount rate is the key to appropriately valuing future cash flows, whether earnings or debt obligations. In order to calculate the present value, you must assume that a rate of return on investment will be generated over time.