Question

On January 1, Ott Company sold goods to Fox Company. Fox signed a noninterest-bearing note requiring payment of $60,000 annually for 7 years. The first payment was made on January 1. The prevailing rate of interest for this type of note at date of issuance was 10%. Information on present value factors is as follows:

Periods Present Value of 1 at 10% Present Value of Ordinary Annuity of 1 at 10%
6 .56 4.36
7 .51 4.87
Ott should record sales revenue in January of
a. $214,200
b. $261,600
c. $292,600
d. $321,600

Answer 1

Ott Company should record a sales revenue of $321,600 in January. This is calculated by adding the present value of the first payment of $60,000 to the present value of the remaining payments, discounted at a rate of 10%, resulting in $321,600.

Step-by-step explanation:

To calculate the sales revenue that Ott Company should record in January, we must find the present value of the noninterest-bearing note signed by Fox Company. Since the first payment of $60,000 is made on January 1 (the same day as the note issuance), its present value is $60,000.

The remaining six payments must be discounted back to their present values using the given annual interest rate of 10%.

The present value of an ordinary annuity of 1 at 10% for 6 periods is 4.36. To find the present value of the remaining payments, we multiply the annuity factor by the annual payment amount: $60,000 × 4.36 = $261,600.

Therefore, the total sales revenue recorded in January is the sum of the first payment and the present value of the remaining payments: $60,000 + $261,600 = $321,600.

To relate this concept to bonds, consider a two-year bond issued for $3,000 at an interest rate of 8%. Using a discount rate of 8%, the present discounted value can be found.

If interest rates increase, causing the discount rate to rise to 11%, the present discounted value of the bond will decrease, illustrating interest rate risk.