?The McGraw-Hill Companies,Inc.,1999
Slide
10-1
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Chapter 10
Liabilities
The McGraw-Hill Companies,Inc.,1999
Slide
10-2
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The Nature of Liabilities
I.O.U.
Defined as debts or obligations
arising from past transactions or
events.
Maturity = 1 year or less Maturity > 1 year
Current
Liabilities
Noncurrent
Liabilities
The McGraw-Hill Companies,Inc.,1999
Slide
10-3
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Distinction Between Debt and
Equity
The acquisition of assets is financed from
two sources:
Funds from creditors,with
a definite due date,and
sometimes bearing
interest.
Funds from
owners
DEBT EQUITY
The McGraw-Hill Companies,Inc.,1999
Slide
10-4
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Liabilities
Question
Devon Mfg,borrows $100,000 from First
Bank,The loan will be repaid in 20 years
and has an annual interest rate of 8%.
Is this a current liability or a
noncurrent liability?
The McGraw-Hill Companies,Inc.,1999
Slide
10-5
Irwin/McGraw-Hill
Liabilities
Question
The obligation will not be paid
within one year or one operating
cycle,so it is a noncurrent liability.
Devon Mfg,borrows $100,000 from First
Bank,The loan will be repaid in 20 years
and has an annual interest rate of 8%.
Is this a current liability or a
noncurrent liability?
The McGraw-Hill Companies,Inc.,1999
Slide
10-6
Irwin/McGraw-Hill
Evaluating Liquidity
Current Ratio = Current Assets?Current Liabilities
Working Capital = Current Assets - Current Liabilities
An important indicator of a company抯
ability to meet its current obligations.
Two commonly used measures:
The McGraw-Hill Companies,Inc.,1999
Slide
10-7
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Liabilities
Question
Devon Mfg,has current liabilities of
$230,000 and current assets of $322,000.
What is Devon’s current ratio?
The McGraw-Hill Companies,Inc.,1999
Slide
10-8
Irwin/McGraw-Hill
Liabilities
Question
C ur r e nt
R a t i o
=
C ur r e nt
A s s e t s
C ur r e nt
Li a bi l i t i e s
= 3 2 2,0 0 0$ 2 3 0,0 0 0$
= 1, 4
Devon Mfg,has current liabilities of
$230,000 and current assets of $322,000.
What is Devon’s current ratio?
The McGraw-Hill Companies,Inc.,1999
Slide
10-9
Irwin/McGraw-Hill
Accounts Payable
Short-term obligations to suppliers for purchases of
merchandise and to others for goods and services.
Merchandise
Inventory
invoices
Shipping
charges
Utility and
phone bills
Office
supplies
invoices
The McGraw-Hill Companies,Inc.,1999
Slide
10-10
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Notes Payable
Current Notes Payable
Noncurrent Notes Payable
Total Notes
Payable
When a company borrows money,a note payable is
created.
Current Portion of Notes Payable
The portion of a note payable that is due within one
year,or one operating cycle,whichever is longer.
The McGraw-Hill Companies,Inc.,1999
Slide
10-11
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Notes Payable
PROMISSORY NOTE
Location Date
after this date
promises to pay to the order of
the sum of with interest at the rate
of per annum.
signed
title
Miami,Fl Nov,1,1999
Six months Porter Company
John Caldwell
Security National Bank
$10,000.00
12.0%
treasurer
The McGraw-Hill Companies,Inc.,1999
Slide
10-12
Irwin/McGraw-Hill
Notes Payable
On November 1,1999,Porter Company
would make the following entry.
D a t e D e s c r i pt i on D e bi t C r e di t
1 - N o v C a s h 1 0,0 0 0
N o t e P a y a b l e 1 0,0 0 0
The McGraw-Hill Companies,Inc.,1999
Slide
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Irwin/McGraw-Hill
?Interest expense is the
compensation to the lender for
giving up the use of money for a
period of time.
?The liability is called interest
payable.
?To the lender,interest is a
revenue.
?To the borrower,interest is an
expense.
Interest
Rate Up!
Interest Payable
The McGraw-Hill Companies,Inc.,1999
Slide
10-14
Irwin/McGraw-Hill
The interest formula includes three variables
that must be considered when computing
interest:
Interest = Principal?Interest Rate?Time
When computing interest for
one year,time?equals 1,
When the computation
period is less than one year,
then time?is a fraction.
Interest Payable
For example,if we needed to
compute interest for 3
months,time?would be 3/12.
The McGraw-Hill Companies,Inc.,1999
Slide
10-15
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What entry would Porter Company make
on December 31,the fiscal year-end?
Interest Payable
Example
D a t e D e s c r i pt i on D e bi t C r e di t
The McGraw-Hill Companies,Inc.,1999
Slide
10-16
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Interest Payable
Example
On December 31,Porter Company would
record interest payable with the following
entry:
$10,000???12% ??2/12 = $200
D a t e D e s c r i pt i on D e bi t C r e di t
3 1 - D e c I n t e r e s t E x p e n s e 200
I n t e r e s t P a y a b l e 200
The McGraw-Hill Companies,Inc.,1999
Slide
10-17
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Payroll Liabilities
Employers incur
several
expenses and
liabilities from
having
employees.
The McGraw-Hill Companies,Inc.,1999
Slide
10-18
Irwin/McGraw-Hill
FICA Taxes Medicare Taxes Federal Income Tax
State and
Local Income
Taxes
Voluntary
Deductions
Net Pay
Gross Pay
Payroll Liabilities
The McGraw-Hill Companies,Inc.,1999
Slide
10-19
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Deferred
revenue is
recorded.
Deferred
revenue is a
liability
account.
Cash is
received
in
advance.
Cash is sometimes collected from the
customer before the revenue is
actually earned.
Unearned Revenue
The McGraw-Hill Companies,Inc.,1999
Slide
10-20
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Earned
revenue is
recorded.
As the earnings
process is
completed,,,
Deferred
revenue is
recorded.
Cash is
received
in
advance.
Unearned Revenue
Cash is sometimes collected from the
customer before the revenue is
actually earned.
The McGraw-Hill Companies,Inc.,1999
Slide
10-21
Irwin/McGraw-Hill
Relatively small debt
needs can be filled from
single sources.
Banks
Insurance
Companies
Pension
Plans
or or
Long-Term Debt
The McGraw-Hill Companies,Inc.,1999
Slide
10-22
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Large debt needs are often
filled by issuing bonds.
Long-Term Debt
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10-23
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Installment Notes Payable
Long-term notes that call for a series of
installment payments.
Each payment covers
interest for the period
AND a portion of the
principal.
With each payment,the
interest portion gets
smaller and the principal
portion gets larger.
The McGraw-Hill Companies,Inc.,1999
Slide
10-24
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Allocating Installment Payments
Between Interest and Principal
?Identify the unpaid principal
balance.
?Unpaid Principal?Interest rate =
Interest expense.
?Installment payment - Interest
expense = Reduction in unpaid
principal balance.
?Compute new unpaid principal
balance.
The McGraw-Hill Companies,Inc.,1999
Slide
10-25
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Allocating Installment Payments
Between Interest and Principal
On January 1,1999,Rocket
Corp,borrowed $7,851.57 from
First Bank of River City,The
loan was a five-year loan and
had an interest rate of 10%,The
annual payment is $2,000.
Prepare an amortization table for
Rocket Corp.’s loan.
The McGraw-Hill Companies,Inc.,1999
Slide
10-26
Irwin/McGraw-Hill
Allocating Installment Payments
Between Interest and Principal
D a t e P a y m e n t
I n t e r e s t
E x p e n s e
R e d u c t i o n i n
U n p a i d
B a l a n c e
U n p a i d
B a l a n c e
J a n, 1,1 9 9 9 7,5 8 1, 5 7$
J a n, 1,2 0 0 0 2,0 0 0, 0 0$ 7 5 8, 1 6$ 1,2 4 1, 8 4$ 6,3 3 9, 7 3
J a n, 1,2 0 0 1 2,0 0 0, 0 0 6 3 3, 9 7 1,3 6 6, 0 3 4,9 7 3, 7 0
J a n, 1,2 0 0 2 2,0 0 0, 0 0 4 9 7, 3 7 1,5 0 2, 6 3 3,4 7 1, 0 7
J a n, 1,2 0 0 3 2,0 0 0, 0 0 3 4 7, 1 1 1,6 5 2, 8 9 1,8 1 8, 1 8
J a n, 1,2 0 0 4 2,0 0 0, 0 0 1 8 1, 8 2 1,8 1 8, 1 8 ( 0, 0 0 )
Now,prepare the entry for the first payment on
January 1,2000.
The McGraw-Hill Companies,Inc.,1999
Slide
10-27
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Allocating Installment Payments
Between Interest and Principal
The information needed for the journal entry can be
found on the amortization table,The payment
amount,the interest expense,and the amount to
credit to principal are all on the table,
D a t e D e s c r i pt i on D e bi t C r e di t
3 1 - D e c I n t e r e s t E x p e n s e 7 5 8, 1 6
N o t e P a y a b l e 1,2 4 1, 8 4
C a s h 2,0 0 0, 0 0
The McGraw-Hill Companies,Inc.,1999
Slide
10-28
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Bonds Payable
? Bonds usually involve the
borrowing of a large sum of
money,called principal.
? The principal is usually paid
back as a lump sum at the
end of the bond period.
? Individual bonds are often
denominated with a par
value,or face value,of
$1,000.
The McGraw-Hill Companies,Inc.,1999
Slide
10-29
Irwin/McGraw-Hill
Bonds Payable
?Bonds usually carry a stated
rate of interest,also called a
contract rate.
?Interest is normally paid
semiannually.
?Interest is computed as:
Interest = Principal? Stated Rate? Time
The McGraw-Hill Companies,Inc.,1999
Slide
10-30
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Bonds Payable
?Bonds are issued through an
intermediary called an
underwriter.
?Bonds can be sold on organized
securities exchanges.
?Bond prices are usually quoted
as a percentage of the face
amount.
? For example,a $1,000 bond priced
at 102 would sell for $1,020.
The McGraw-Hill Companies,Inc.,1999
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10-31
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Types of Bonds
Mortgage
Bonds
Convertible
Bonds Junk Bonds
Debenture
Bonds
The McGraw-Hill Companies,Inc.,1999
Slide
10-32
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Accounting for Bonds Payable
On January 1,2000,Rocket Corp,issues $1,500,000 of
12%,10-year bonds payable,Interest is payable
semiannually,each July 1 and January 1.
Assume the bonds are issued at face value,Record the
issuance of the bonds.
D a t e D e s c r i pt i on D e bi t C r e di t
The McGraw-Hill Companies,Inc.,1999
Slide
10-33
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Accounting for Bonds Payable
On January 1,2000,Rocket Corp,issues $1,500,000 of
12%,10-year bonds payable,Interest is payable
semiannually,each July 1 and January 1.
Assume the bonds are issued at face value,Record the
issuance of the bonds.
D a t e D e s c r i pt i on D e bi t C r e di t
1 - J a n C a s h 1,5 0 0,0 0 0
B o n d s P a y a b l e 1,5 0 0,0 0 0
The McGraw-Hill Companies,Inc.,1999
Slide
10-34
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Accounting for Bonds Payable
Record the interest payment on July 1,
2000.
D a t e D e s c r i pt i on D e bi t C r e di t
The McGraw-Hill Companies,Inc.,1999
Slide
10-35
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Accounting for Bonds Payable
Record the interest payment on July 1,
2000.
D a t e D e s c r i pt i on D e bi t C r e di t
1 - J u l I n t e r e s t E x p e n s e 9 0,0 0 0
C a s h 9 0,0 0 0
The McGraw-Hill Companies,Inc.,1999
Slide
10-36
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Bonds Sold Between Interest Dates
?Bonds are often sold between interest
dates.
?The selling price of the bond is computed
as:
P r ese n t val u e o f t h e b o n d
+ A ccr u ed i n t er est si n ce t h e
l ast i n t er est p aym en t
= S el l i n g p r i ce o f t h e b o n d
The McGraw-Hill Companies,Inc.,1999
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Irwin/McGraw-Hill
Let’s look at the
present value
concept! Hold
on tight!
The McGraw-Hill Companies,Inc.,1999
Slide
10-38
Irwin/McGraw-Hill
The Concept of Present Value
$1,000
invested
today at 10%.
Money can grow over time,
because it can earn interest.
The McGraw-Hill Companies,Inc.,1999
Slide
10-39
Irwin/McGraw-Hill
$1,000
invested
today at 10%.
In 5 years it
will be worth
$1,610.51.
In 25 years it
will be worth
$10,834.71!
Present
Value
Future
Value
The Concept of Present Value
The McGraw-Hill Companies,Inc.,1999
Slide
10-40
Irwin/McGraw-Hill
How much is a future amount worth
today?
Today
Present
Value
FutureV
alue
Interest compounding periods
The Concept of Present Value
The McGraw-Hill Companies,Inc.,1999
Slide
10-41
Irwin/McGraw-Hill
How much is a future amount worth
today?
Three pieces of information must be
known to solve a present value problem:
?The future amount.
?The interest rate (i).
?The number of periods (n) the amount will be
invested.
The Concept of Present Value
The McGraw-Hill Companies,Inc.,1999
Slide
10-42
Irwin/McGraw-Hill
Two types of cash flows are involved
with bonds:
Today
?Principal payment
at maturity.
?Periodic interest payments called annuities.
Maturity
The Concept of Present Value
The McGraw-Hill Companies,Inc.,1999
Slide
10-43
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The Present Value Concept and
Bond Prices
P r es ent V al ue of t he P r i nci pal ( a si ng l e paym ent )
+ P r es ent V al ue of t he I nt er es t P ay m ent s ( an annu i t y)
= S el l i ng P r i ce of t he B on d
The selling price of the bond is
determined by the market based on the
time value of money.
The McGraw-Hill Companies,Inc.,1999
Slide
10-44
Irwin/McGraw-Hill
The Present Value Concept and
Bond Prices
The selling price of the bond is
determined by the market based on the
time value of money.
I n t e r e s t B o n d A c c o u n t i n g f o r
R a t e s P r i c e t h e D i f f e r e n c e
S t a t e d M a r k e t B o n d P a r V a l u e T h e r e i s n o d i f f e r e n c e
R a t e R a t e P r i c e o f t h e B o n d t o a c c o u n t f o r,
S t a t e d M a r k e t B o n d P a r V a l u e T h e d i f f e r e n c e i s a c c o u n t e d
R a t e R a t e P r i c e o f t h e B o n d f o r a s a b o n d d i s c o u n t,
S t a t e d M a r k e t B o n d P a r V a l u e T h e d i f f e r e n c e i s a c c o u n t e d
R a t e R a t e P r i c e o f t h e B o n d f o r a s a b o n d p r e m i u m,
=
>
<
>
<
=
The McGraw-Hill Companies,Inc.,1999
Slide
10-45
Irwin/McGraw-Hill
Early Retirement of Debt
Gains or losses incurred as a result of retiring
bonds should be reported as extraordinary
items on the income statement.
E x e r c i s i n g a c a l l
p r o v i s i o n,
P u r c h a s i n g t h e
b o n d s o n t h e
o p e n m a r k e t,
B o n d s c a n b e
re tire d b y,,,
The McGraw-Hill Companies,Inc.,1999
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10-46
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Lease Payment Obligations
Capital Leases
Lease agreement transfers
risks and benefits
associated with ownership
to lessee.
Lessee records a leased
asset and lease liability.
Operating Leases
Lessor retains risks and
benefits associated with
ownership.
Lessee records rent
expense as incurred.
The McGraw-Hill Companies,Inc.,1999
Slide
10-47
Irwin/McGraw-Hill
Capital Lease Criteria
T h e l e a s e t ra n s f e rs
o w n e rs h i p t o t h e
l e s s e e,
T h e l e a s e c o n t a i n s
a b a rg a i n p u rc h a s e
o p t i o n,
T h e l e a s e t e rm i s e q u a l t o
o r > 7 5 % o f t h e e c o n o m i c
l i f e o f t h e p ro p e rt y,
T h e P V o f t h e m i n i m u m
l e a s e p a y m e n t s = 9 0 % o f
t h e F M V o f t h e p ro p e rt y,
A l e a s e m u s t b e re c o rd e d a s
a C a p i t a l L e a s e i f i t m e e t s
a n y o f t h e f o l l o w i n g c ri t e ri a,
The McGraw-Hill Companies,Inc.,1999
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10-48
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Pensions
Employers offer pension
plans to employees.
Retirees receive
pension
payments from
the pension
fund.
The employer makes
payments to a pension
fund,Usually,this is an
independent entity
managed by a
professional fund
manager.
The McGraw-Hill Companies,Inc.,1999
Slide
10-49
Irwin/McGraw-Hill
Pensions
Actuaries make the pension expense
computations,based on:
? Avg,age,retirement age,life
expectancy.
? Employee turnover rates.
? Compensation levels.
? Expected rate of return for the fund.
The accountant then posts the entry to
record pension expense and pension
liability.
The McGraw-Hill Companies,Inc.,1999
Slide
10-50
Irwin/McGraw-Hill
Other Postretirement Benefits
Many companies offer benefits to
retirees other than pensions,such
as health coverage or fitness club
memberships.
D a t e D e s c r i pt i on D e bi t C r e di t
N o n p e n s i o n P o s tr e ti r e m e n t
B e n e fi ts E x p e n s e $$$
C a s h $$$
U n fu n d e d L i a b i l i ty fo r
N o n p e n s i o n P o s tr e ti r e m e n t B e n e fi ts $$$
The unfunded liability must be
disclosed on the employer抯
balance sheet,
The McGraw-Hill Companies,Inc.,1999
Slide
10-51
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Deferred Income Taxes
Corporations
pay income
taxes
quarterly.
The McGraw-Hill Companies,Inc.,1999
Slide
10-52
Irwin/McGraw-Hill
The difference between tax expense and tax
payable is recorded in an account called
deferred taxes.
The Internal Revenue
Code is the set of
rules for preparing tax
returns.
Financial statement
income tax expense.
IRS income taxes
payable.
GAAP is the set of
rules for preparing
financial statements.
Results in,,, Results in,,,Usually.,,
Deferred Income Taxes
The McGraw-Hill Companies,Inc.,1999
Slide
10-53
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Examine the December 31,1998 information
for X-Off Inc.
X-Off uses straight-line depreciation for financial
reporting and accelerated depreciation for
income tax reporting,X-Off’s tax rate is 30%.
R even u es 1,000,000$
D ep r eci at i o n E xp en se:
S t r a ig h t - lin e 200,000
A c c e le r a t e d 320,000
O t h er E xp en ses 650,000
Deferred Income Taxes
Example
The McGraw-Hill Companies,Inc.,1999
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I n c o m e T a x
S t a t e m e n t R e t u r n D i f f e r e n c e
R e v e nue s 1,0 0 0,0 0 0$
Le s s,
D e pr e c i a t i on 2 0 0,0 0 0
O t he r e x pe ns e s 6 5 0,0 0 0
I nc om e be f or e t a x e s 1 5 0,0 0 0$
Ta x r a t e 30%
I nc om e t a x e s 4 5,0 0 0$
The income tax
amount computed
based on financial
statement income
is income tax
expense for the
period.
Deferred Income Taxes
Example
Compute X-Off抯 income tax expense
and income tax payable.
The McGraw-Hill Companies,Inc.,1999
Slide
10-55
Irwin/McGraw-Hill
Compute X-Off’s income tax expense
and income tax payable.
I n c o m e T a x
S t a t e m e n t R e t u r n D i f f e r e n c e
R e v e nue s 1,0 0 0,0 0 0$ 1,0 0 0,0 0 0$
Le s s,
D e pr e c i a t i on 2 0 0,0 0 0 3 2 0,0 0 0
O t he r e x pe ns e s 6 5 0,0 0 0 6 5 0,0 0 0
I nc om e be f or e t a x e s 1 5 0,0 0 0$ 3 0,0 0 0$
Ta x r a t e 30% 30%
I nc om e t a x e s 4 5,0 0 0$ 9,0 0 0$
Income taxes
based on tax
return
income are
the taxes
payable for
the period.
Deferred Income Taxes
Example
The McGraw-Hill Companies,Inc.,1999
Slide
10-56
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I n c o m e T a x
S t a t e m e n t R e t u r n D i f f e r e n c e
R e v e nue s 1,0 0 0,0 0 0$ 1,0 0 0,0 0 0$ -$
Le s s,
D e pr e c i a t i on 2 0 0,0 0 0 3 2 0,0 0 0 ( 1 2 0,0 0 0 )
O t he r e x pe ns e s 6 5 0,0 0 0 6 5 0,0 0 0 -
I nc om e be f or e t a x e s 1 5 0,0 0 0$ 3 0,0 0 0$ 1 2 0,0 0 0$
Ta x r a t e 30% 30% 30%
I nc om e t a x e s 4 5,0 0 0$ 9,0 0 0$ 3 6,0 0 0$
The deferred tax for the period of $36,000 is the
difference between income tax expense of $45,000 and
income tax payable of $9,000.
Deferred Income Taxes
Example
The McGraw-Hill Companies,Inc.,1999
Slide
10-57
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Financial Leverage
Borrowing at
one rate and
investing at a
higher rate.
If we borrow
$1,000,000 at 8% and
invest it at 10%,we
will clear $20,000
profit!
The McGraw-Hill Companies,Inc.,1999
Slide
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End of Chapter 10
I wonder
what the
present
value of my
last hairdo
is?