Question

On July 1, Goblette Company sold some machinery to another company. The two companies entered into an installment sales contract at a predetermined interest rate. The contract required 5 equal annual payments with the first payment due on July 1, the date of sale. What present value concept is appropriate for this situation?

a) Present value of an annuity due of $1 for 5 periods.
b) Present value of an ordinary annuity of $1 for 5 periods.
c) Future amount of an annuity due of $1 for 5 periods.
d) Future amount of $1 for 5 periods.

Answer 1

The correct concept for calculating the current worth of a series of payments made at the beginning of each period, as in the Goblette Company case, is the present value of an annuity due.

Step-by-step explanation:

In the scenario described, where Goblette Company sold machinery and entered into an installment sales contract requiring 5 equal annual payments with the first payment due on the sale date, the appropriate present value concept to apply is a) Present value of an annuity due of $1 for 5 periods.

This is because an annuity due refers to a series of payments made at the beginning of each period, which is the case here since the first payment is due immediately on July 1, the date of sale. The present value calculation will require a predetermined interest rate to determine the current worth of the future payments. This valuation is important for understanding the cost or value of the contract in today's dollars.

Annuity due is an annuity whereby the payment is normally due at the beginning of every period which can be annually, semi annually, monthly, or quarterly. Examples of payments with annuity due include rents and, leases.

In ordinary annuity, the main difference is that the payments have to be made at the end of every period.

It should be noted that the present value of an annuity due is typically worth more when it is compared to the present value of ordinary annuity.