Present Value - Accounting Examples (for excel download: PV2)

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Example 3:  Cash or Note Payable?  Which is the better choice?
  • XYZ Company is negotiating with WWW Company to purchase equipment. WWW offers the following alternatives:
    • The equipment could be purchased for $10,000 cash Or
    • XYZ could pay $108,000 one year from now.
    • a.  XYZ can earn 12% on investments
    • b.  XYZ can only earn 6% on its investments
Case a.  Equation:

$108,000 * PV(12%,1) = X

 Calculation:

Amount

PV(12%,1)

Present value

$108,000

0.89286

$96,429

< $100,000
Since the present value of $108,000 discounted at 12% is less than $100,000 (the cash price), XYZ should sign the note and in the meantime invest the $100,000 at 12%.
Case b.  Equation:

$108,000 * PV(6%,1) = X

 Calculation:

Amount

PV(6%,1)

Present value

$108,000

0.9434

$101,887

> $100,000
Since the present value of $108,000 discounted at 6% is more than $100,000 (the cash price), XYZ should pay cash now.
The same principles would apply if instead of making a single payment, several payments (annuity!) were required.

Return to: home| basic PV  | pv & accounting | annuities I  |  annuities II | Examples: 1 - PV of Note Receivable | 2 - Issuance of Bond | 3: Cash or Note Payable? | 4 A: Buying a car - interest rate? |4 B: Buying a car - payments: | Quizz Practice quizz (from an old text book, but still working)