Question

At the beginning of 2018, VHF Industries acquired a equipment with a fair value of $8,710,520 by issuing a six-year, noninterest-bearing note in the face amount of $12 million. The note is payable in six annual installments of $2 million at the end of each year. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)

Required:

1. What is the effective rate of interest implicit in the agreement?
2. to 4. Prepare the necessary journal entry.
5. Suppose the market value of the equipment was unknown at the time of purchase, but the market rate of interest for notes of similar risk was 9%. Prepare the journal entry to record the purchase of the equipment.

Answer 1

1)	Fair value	=	87,10,520
	Note payable	=	1,20,00,000
	The implicit rate where inflow= outflow
	Inflow	=	PV of outflow
	87,10,520	=	20,00,000	* PVAF (rate, 6 years)
	87,10,520/20,00,000	=	PVAF (rate, 6 years)
	4.35526	=	PVAF (rate, 6 years)
	Finding this value in PVAF table, which is at 10%
	So, PVAF (10%,6 years)	=	4.35526
2)	Machine	87,10,520
	Installment Notes Payable		87,10,520
	( Purchase of machine)
3)	Date	Payment	Interest @ 10%		Principal	Balance
	01-01-2018					87,10,520
	31-12-2018	20,00,000	8,71,052	(87,10,520*10%)	11,28,948	75,81,572
	31-12-2019	20,00,000	7,58,157	(75,81,572*10%)	12,41,843	63,39,729
	31-12-2020	20,00,000	6,33,973	(63,39,729*10%)	13,66,027	49,73,702
	31-12-2021	20,00,000	4,97,370	(49,73,702*10%)	15,02,630	34,71,072
	31-12-2022	20,00,000	3,47,107	(34,71,072*10%)	16,52,893	18,18,180
	31-12-2023	20,00,000	1,81,820		18,18,180	0
	Ist Installment payment
	Installment Notes Payable	11,28,948
	Interest Expense	8,71,052
	Cash		20,00,000
4)	2nd Installemt payment
	Installment Notes Payable	12,41,843
	Interest Expense	7,58,157
	Cash		20,00,000
5)	Present value of future payment
	6 payments @ 9%	=	4.486*20,00,000
		=	89,72,000
	Machine	89,72,000
	Installment Notes Payable		89,72,000