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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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BuyFindarrow_forward

Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem
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Cash Flow Amounts On January 1, 2019, Charles Jamison borrows $40,000 from his father to open a business. Charles is the beneficiary of a trust created by his aunt from which he will receive $25,000 on January 1, 2029. He signs an agreement to make this amount payable to his father and, further, to pay his father equal annual amounts from January 1, 2020, to January 1, 2028, inclusive, in retirement of the debt. Interest is 12% per year.

Required:

What are the annual payments?

To determine

Determine the equal annual payment.

Explanation

Annuity: An annuity is referred as a sequence of payment of fixed amount of cash flows that occurs over the equal intervals of time.

Cash flow occurs during the first day of each time period is known as an annuity due, whereas cash flow occurs during the last day of each time period is known as an ordinary annuity.

First, convert the future receipt of $25,000 to present value as on January 1, 2019.

PV=FV×(pn=10,i=12%)=$25,000×0.321973=$8,049.33

Hence, the present value of future trust receipt as on January 1, 2019 is $8,049.33.

Factor 0.321973 is taken from the Present value of $1 table (Table 3 at the end of the time value money module), where n=10, i=12%.

Now, calculate the present value of total annual payments, using present value ordinary annuity formula (because future payments are made in installment).

PVo=Present value of LoanPresent value offuture recepits from trust=$40,000$8,049

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