Question

At the beginning of 2021, VHF Industries acquired a machine with a fair value of $4,803,660 by issuing a three-year, noninterest-bearing note in the face amount of $6 million. The note is payable in three annual installments of $2 million at the end of each year. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)

Required:
1. What is the effective rate of interest implicit in the agreement?
2. to 4. Prepare the necessary journal entries.
5. Suppose the market value of the machine was unknown at the time of purchase, but the market rate of interest for notes of similar risk was 11%. Prepare the journal entry to record the purchase of the machine.

Answer 1

Solution:

Fair Market Value	4803660
Yearly Payment / PMT	2000000
No. of years	3
Using the Financial Calulator/ or RATE function in Excel, the effective rate is	12%

Else we can use the tables for PV of an annuity, Where PV = Annuity x Factor. With this lets find the factor which equals PV/Annuity = 4803660/200000 = 2.40183, which corresponds to 3 installments at 12%

2-4

Journal Entries
Machinery	4803660
Discount on Notes Payable	1196340
Notes Payable		6000000
( To record the Purchase of Equipment)
Interest Expense (4803660*12%)	576439.2
Discount on Notes Payable		576439.2
(To record the amortisation of Discount)
Notes Payable	2000000
Cash		2000000
(To Record the payment of first installment)
Interest Expense (4803660-(2000000-576439.2))*12%)	405611.9
Discount on Notes Payable		405611.9
(To record the amortisation of Discount)
Notes Payable	2000000
Cash		2000000
(To Record the payment of first installment)

Amortization Table
	Installment (A)	Interest Expense (B) = (D*12%)	Reduction in Notes Payable (c ) = A-B	PV of Notespayable (D)
0				4803660
1	2000000	576439	1423561	3380099
2	2000000	405612	1594388	1785711
3	2000000	214285	1785715	-4

5.

WHen the Interest rate is 11%, The present value of annuities of $2000,000 for 3 years is

Pmt	$20,00,000	Payments of a fixed amount
i	11.00%	Interest Rate
n	3	no of payment period

PV factor @ 11% for 3 periods= 2.4437

PV = $2000,000*2.44371 = $4,887,429.43

Journal Entries
Machinery	4887429
Discount on Notes Payable	1112571
Notes Payable		6000000
( To record the Purchase of Equipment)

Hope this helps! In case of any clarifications, kindly use the comment box below