Final answer:
Of the first $14,903 payment on the installment note, $8,000 was applied to interest, and the remaining $6,903 was applied to the principal. A simple two-year bond example illustrates the effect of discount rates on the present value of future cash flows.
Step-by-step explanation:
The student's question asks about the allocation of a payment towards interest on an installment note. On January 1, Year 1, Barnes Company issued a $100,000 installment note with a 10-year term and an 8 percent interest rate, with repayment in 10 annual payments of $14,903. To determine the portion of the first payment applied to interest, you calculate the first year's interest by multiplying the principal amount by the interest rate of 8%. Therefore, the first year's interest is $8,000 ($100,000 × 0.08). Consequently, of the first $14,903 payment, $8,000 was applied to interest, and the remaining $6,903 would reduce the principal.
Applying this understanding to a different situation, let's consider a simple two-year bond. If the bond was issued for $3,000 at an interest rate of 8%, it would pay $240 in interest each year. If you use an 8% discount rate, you would find the present value of these future cash flows to be equivalent to their face value, since the discount rate matches the interest rate. However, if the discount rate increases to 11%, the present value of the bond would decrease, because the value of future payments is worth less today when discounted at the higher rate.