Final answer:
The second journal entry for discounting a $20,000 note using an 8% discount rate will involve recording the discounted amount and the proceeds. Present value calculations for bonds use discount rates to determine the current worth of future payments, which decrease if discount rates increase, due to the higher cost of future cash flows.
Step-by-step explanation:
Understanding Discounted Notes
When a $20,000 note is discounted at a local bank with an 8% discount rate and without recourse, the sale criteria must be satisfied. The second journal entry to record the discounting transaction will reflect the proceeds received by the company after the bank has deducted the discount amount. The discount is calculated by multiplying the note's face value by the discount rate and the proportion of the year the note is held before maturity.
If we apply this to a simple two-year bond example, the bond was issued for $3,000 at an 8% interest rate, which leads to $240 in interest each year. To find the present value of this bond at an 8% discount rate, you would discount each of the interest payments as well as the principal repayment that occurs at the end of the bond term. If the discount rate increases to 11%, the present value of the bond would decrease because the future cash flows are discounted at a higher rate, making them less valuable in today's terms.
Bonds and Present Value
The present value formula is used to calculate the current worth of a future stream of payments. This involves discounting future cash flows back to their value today, taking into account the time value of money. The present value is lower if the discount rate is higher because you are effectively stating that money in the future is worth less compared to money today.
The bond's present value can be calculated using the formula for present value of an annuity for the interest payments and the present value of a lump sum for the final principal repayment. Specifically, the formula is: PV = P/(1+r)^n, where PV is the present value, P is the payment or principal, r is the discount rate, and n is the number of periods until payment.