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Chapter 12: Q15SE (page 658)

Determining future value

David is entering high school and is determined to save money for college. David feels

he can save $5,000 each year for the next four years from his part-time job. If David is

able to invest at 6%, how much will he have when he starts college?

Short Answer

Expert verified

David will have $21,875 when he starts college.

Step by step solution

01

Definition of future value

The future value is the valuation of the current investment at future date.

02

Calculation of future value

Future Value= Period  Payments × Future value of ordinary annuity of $1=$5,000× 4.375= $21,875

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Most popular questions from this chapter

Using the effective-interest amortization method

On December 31, 2018, when the market interest rate is 6%, Benson Realty issues

\(700,000 of 6.25%, 10-year bonds payable. The bonds pay interest semiannually. Benson

Realty received \)713,234 in cash at issuance.

Requirements

1. Prepare an amortization table using the effective interest amortization method for

the first two semiannual interest periods. (Round to the nearest dollar.)

2. Using the amortization table prepared in Requirement 1, journalize issuance of the

bonds and the first two interest payments.

Bill and Edna had been married two years and had just reached the point where they

had enough savings to start investing. Bill’s uncle Dave told them that he had recently

inherited some very rare railroad bonds from his grandmother’s estate. He wanted

to help Bill and Edna get a start in the world and would sell them 50 of the bonds at

\(100 each. The bonds were dated 1873, beautifully engraved, showing a face value of

\)1,000 each. Uncle Dave pointed out that “United States of America” was printed

prominently at the top and that the U.S. government had established a sinking fund to

retire the old railroad bonds. A sinking fund is a fund established for the purpose of

repaying the debt. It allows the organization (the U.S. government, in this example)

to set aside money over time to retire the bonds. All Bill and Edna needed to do was

hold on to them until the government contacted them, and they would eventually get

the full \(1,000 for each bond. Bill and Edna were overjoyed—until a year later when

they saw the exact same bonds for sale at a coin and stamp shop priced as “collectors’

items” for \)9.95 each!

Requirements

1. If a company goes bankrupt, what happens to the bonds it issued and the investorswho bought the bonds?

2. When investing in bonds, how can you tell whether the bond issue is a legitimatetransaction?

3. Is there a way to determine the relative risk of corporate bonds?

Your grandfather would like to share some of his fortune with you. He offers to give

you money under one of the following scenarios (you get to choose):

1. \(8,750 per year at the end of each of the next six years

2. \)49,650 (lump sum) now

3. $100,450 (lump sum) six years from now

C H A P T E R 1 2

Requirements

1. Calculate the present value of each scenario using a 6% discount rate. Which scenario

yields the highest present value? Round to the nearest dollar.

2. Would your preference change if you used a 12% discount rate?

Analyzing and journalizing bond transactions

On January 1, 2018, Educators Credit Union (ECU) issued 8%, 20-year bonds payablewith face value of $1,000,000. These bonds pay interest on June 30 and December 31.The issue price of the bonds is 109.Journalize the following bond transactions:

a. Issuance of the bonds on January 1, 2018.

b. Payment of interest and amortization on June 30, 2018.

c. Payment of interest and amortization on December 31, 2018.

d. Retirement of the bond at maturity on December 31, 2037, assuming the lastinterest payment has already been recorded.

Determining bond prices and interest expense

Jones Company is planning to issue $490,000 of 9%, five-year bonds payable to

borrow for a major expansion. The owner, Shane Jones, asks your advice on some

related matters.

Requirements

1. Answer the following questions:

a. At what type of bond price Jones Company will have total interest expense

equal to the cash interest payments?

b. Under which type of bond price will Jones Company’s total interest expense be

greater than the cash interest payments?

c. If the market interest rate is 12%, what type of bond price can Jones Company

expect for the bonds?

2. Compute the price of the bonds if the bonds are issued at 89.

3. How much will Jones Company pay in interest each year? How much will Jones

Company’s interest expense be for the first year?
See all solutions

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