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Chapter 6: 7P (page 307)

Answer the following questions related to Dubois Inc.

(a) Dubois Inc. has \(600,000 to invest. The company is trying to decide between two alternative uses of the funds. One alternative provides \)80,000 at the end of each year for 12 years, and the other is to receive a single lump-sum payment of \(1,900,000 at the end of the 12 years. Which alternative should Dubois select? Assume the interest rate is constant over the entire investment.

(b) Dubois Inc. has completed the purchase of new Dell computers. The fair value of the equipment is \)824,150. The purchase agreement specifies an immediate down payment of \(200,000 and semiannual payments of \)76,952 beginning at the end of 6 months for 5 years. What is the interest rate, to the nearest percent, used in discounting this purchase transaction?

(c) Dubois Inc. loans money to John Kruk Corporation in the amount of \(800,000. Dubois accepts an 8% note due in 7 years with interest payable semiannually. After 2 years (and receipt of interest for 2 years), Dubois needs money and therefore sells the note to Chicago National Bank, which demands interest on the note of 10% compounded semiannually. What is the amount Dubois will receive on the sale of the note?

(d) Dubois Inc. wishes to accumulate \)1,300,000 by December 31, 2027, to retire bonds outstanding. The company deposits \(200,000 on December 31, 2017, which will earn interest at 10% compounded quarterly, to help in the retirement of this debt. In addition, the company wants to know how much should be deposited at the end of each quarter for 10 years to ensure that \)1,300,000 is available at the end of 2027. (The quarterly deposits will also earn at a rate of 10%, compounded quarterly.) (Round to even dollars.)

Short Answer

Expert verified

The alternative two should be chosen in part A, the interest rate for part B is 4%, the amount receivable in part C is $765,214.4 and the annuity value of quarterly deposits is $11,320.

Step by step solution

01

Computation of part A

Amount to be invested

600,000

Annual receipts in alternative 1

80,000

The effective Interest rate in alternative 1

8% (as per the present value of ordinary annuity table)

Lump-sum receipts in alternative 2

1,900,000

The effective interest rate in alternative 2

10% (as per the future value table )


Alternative two should be chosen as it has a higher effective interest rate

02

Computation of part B

The fair value of equipment

824,150

Down payment

200,000

Present value of total semi-annual payments

624,150

Semi-annual payment

76,952

Interest rate

4% (as per the present value of ordinary annuity table)

03

Computation of part C

Amountreceivable=PVAF+PVIF=800,000×4%×7.7217+800,000×0.6139=247,094.4+491,120=$765,214.4

04

Computation of part D

Initial Amount Deposited

200,000

Table factor

2.68506 (2.5%, 40)

FV of Initial Amount deposited

537,012

Total amount required

1,300,000

Balance amount required

762988

Table factor

67.40255 (2.5%, 40)

Annuity value of quarterly deposits

11320

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Most popular questions from this chapter


Question: At a recent meeting of the accounting staff in your company, the controller raised the issue of using present value techniques to conduct impairment tests for some of the company’s fixed assets. Some of the more senior members of the staff admitted having little knowledge of present value concepts in this context, but they had heard about a FASB Concepts Statement that may be relevant. As the junior staff in the department, you have been asked to conduct some research of the authoritative literature on this topic and report back at the staff meeting next week. Instructions If your school has a subscription to the FASB Codification, go to http://aaahq.org/asclogin.cfm to log in and access the FASB Statements of Financial Accounting Concepts. When you have accessed the documents, you can use the search tool in your Internet browser to respond to the following items. (Provide paragraph citations.) (a) Identify the concept statement that addresses present value measurement in accounting. (b) What are some of the contexts in which present value concepts are applied in accounting measurement? (c) Provide definitions for the following terms: (1) Best estimate. (2) Estimated cash flow (contrasted to expected cash flow). (3) Fresh-start measurement. (4) Interest methods of allocation

James Kirk is a financial executive with McDowell Enterprises. Although James Kirk has not had any formal training in finance or accounting, he has a “good sense” for numbers and has helped the company grow from a very small company (\(500,000 sales) to a large operation (\)45 million in sales). With the business growing steadily, however, the company needs to make a number of difficult financial decisions in which James Kirk feels a little “over his head.” He therefore has decided to hire a new employee with “numbers” expertise to help him. As a basis for determining whom to employ, he has decided to ask each prospective employee to prepare answers to questions relating to the following situations he has encountered recently. Here are the questions.

(a) In 2016, McDowell Enterprises negotiated and closed a long-term lease contract for newly constructed truck terminals and freight storage facilities. The buildings were constructed on land owned by the company. On January 1, 2017, McDowell took possession of the leased property. The 20-year lease is effective for the period January 1, 2017, through December 31, 2036. Advance rental payments of \(800,000 are payable to the lessor (owner of facilities) on January 1 of each of the first 10 years of the lease term. Advance payments of \)400,000 are due on January 1 for each of the last 10 years of the lease term. McDowell has an option to purchase all the leased facilities for \(1 on December 31, 2036. At the time the lease was negotiated, the fair value of the truck terminals and freight storage facilities was approximately \)7,200,000. If the company had borrowed the money to purchase the facilities, it would have had to pay 10% interest. Should the company have purchased rather than leased the facilities?

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Nerwin, Inc. is a furniture manufacturing company with 50 employees. Recently, after a long negotiation with the local labor union, the company decided to initiate a pension plan as a part of its compensation plan. The plan will start on January 1, 2017. Each employee covered by the plan is entitled to a pension payment each year after retirement. As required by accounting standards, the controller of the company needs to report the pension obligation (liability). On the basis of a discussion with the supervisor of the Personnel Department and an actuary from an insurance company, the controller develops the following information related to the pension plan. Average length of time to retirement 15 years Expected life duration after retirement 10 years Total pension payment expected each year after retirement for all employees. Payment made at the end of the year. $700,000 per year The interest rate to be used is 8%.

Instructions On the basis of the information above, determine the present value of the pension obligation (liability).

Your client, Keith Moreland Leasing Company, is preparing a contract to lease a machine to Souvenirs Corporation for a period of 25 years. Moreland has an investment cost of $365,755 in the machine, which has a useful life of 25 years and no salvage value at the end of that time. Your client is interested in earning an 11% return on its investment and has agreed to accept 25 equal rental payments at the end of each of the next 25 years.

Instructions You are requested to provide Moreland with the amount of each of the 25 rental payments that will yield an 11% return on investment.

Andrew Bogut just received a signing bonus of \(1,000,000. His plan is to invest this payment in a fund that will earn 8%, compounded annually. Instructions (a) If Bogut plans to establish the AB Foundation once the fund grows to \)1,999,000, how many years until he can establish the foundation? (b) Instead of investing the entire \(1,000,000, Bogut invests \)300,000 today and plans to make 9 equal annual investments into the fund beginning one year from today. What amount should the payments be if Bogut plans to establish the $1,999,000 foundation at the end of 9 years?
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