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Chapter 6: Q9Q (page 301)
Question:What are the primary characteristics of an annuity? Differentiate between an 鈥渙rdinary annuity鈥� and an 鈥渁nnuity due.鈥�
The annuity has periodic payment and rents occur in beginning in annuities due, rents occur at end of the period in an ordinary annuity
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Craig Brokaw, newly appointed controller of STL, is considering ways to reduce his company鈥檚 expenditures on annual pension costs. One way to do this is to switch STL鈥檚 pension fund assets from First Security to NET Life. STL is a very well-respected computer manufacturer that recently has experienced a sharp decline in its financial performance for the first time in its 25-year history. Despite financial problems, STL still is committed to providing its employees with good pension and postretirement health benefits.
Under its present plan with First Security, STL is obligated to pay \(43 million to meet the expected value of future pension benefits that are payable to employees as an annuity upon their retirement from the company. On the other hand, NET Life requires STL to pay only \)35 million for identical future pension benefits. First Security is one of the oldest and most reputable insurance companies in North America. NET Life has a much weaker reputation in the insurance industry. In pondering the significant difference in annual pension costs, Brokaw asks himself, 鈥淚s this too good to be true?鈥�
Instructions
Answer the following questions.
(a) Why might NET Life鈥檚 pension cost requirement be $8 million less than First Security鈥檚 requirement for the same future value?
(b) What ethical issues should Craig Brokaw consider before switching STL鈥檚 pension fund assets?
(c) Who are the stakeholders that could be affected by Brokaw鈥檚 decision?
Question:Will Smith will receive $80,000 5 years from now, from a trust fund established by his father. Assuming the appropriate interest rate for discounting is 12% (compounded semiannually), what is the present value of this amount today?
Question:Identify three situations in which accounting measures are based on present values. Do these present value applications involve single sums or annuities, or both single sums and annuities? Explain.
Recently, Glenda Estes was interested in purchasing a Honda Acura. The salesperson indicated that the price of the car was either \(27,600 cash or \)6,900 at the end of each of 5 years. Compute the effective-interest rate to the nearest percent that Glenda would pay if she chooses to make the five annual payments.
Clancey Inc. issues $2,000,000 of 7% bonds due in 10 years with interest payable at year-end. The current market rate of interest for bonds of similar risk is 8%. What amount will Clancey receive when it issues the bonds?
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