Question

On 1/1, a firm sold merchandise to a customer, accepting as payment a 5 year, $1000 note receivable, with interest at 5% due at the end of each year. How much interest revenue will be recorded for year 2, under each of the following scenarios: 1. The market rate for this note is 4%. 2. The market rate for this note is 6%. 3. Instead of paying 5% interest, the note is non-interest bearing, but the market rate is 5%. Use the following present value factors, keep all decimals in your calculator at all stages, then round answer to nearest cent: 4% 5% 6% PV factor for 5 years 0.82193 0.78353 .074726 PVOA factor for 5 years 4.45182 4.32948 4.21236

Answer 1

1) Note receivable is paying 5% interest and interest revenue for each year will be equal to face value of note multiplied by interest rate (i.e. 5%). Market rate is not relevant for this case.

Interest revenue for year 2 = Note Value*Interest rate per year

= $1,000*5% = $50 (interest is due at the end of each year)

Therefore interest revenue to be recorded for year 2 is $50.

2) Same as in part 1

Market rate is not relevant for this case.

Interest revenue for year 2 = Note Value*Interest rate per year

= $1,000*5% = $50

Therefore interest revenue to be recorded for year 2 is $50.

3) If the note is non interest bearing, then we need to record the note initially at present value of note discounted at market rate (i.e. 5% in the given case) and then interest revenue for each year will be equal to book value of note multiplied by market rate. Interest revenue at the end of each year will increase the book value of note.

Present Value of Note = Face Value of Note*PV factor for 5 years at 5%

= $1,000*0.78353 = $783.53

Interest revenue for year 1 = $783.53*5% = $39.18

Interest revenue for year 2 = ($783.53+$39.18)*5% = $41.14

Therefore interest revenue to be recorded for year 2 is $41.14.