Zero Coupon Bond (Austral)

In: Business and Management

Submitted By choco36
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The financial concepts known as future value, present value and compound interest are the keys to understanding the economics and the accounting for the proposed zero coupon loan. Let's spend a few moments reviewing these concepts:
Future Value Definition: (quoted from Harvard Business School online course material)
The future value of any amount of money today is the amount that it would be worth if it were invested and grew at the specified compound interest rate over a given time period.
Formula: F=P*(1+r)^n

Present Value Definition:
(Quoted from Harvard Business School online course material)
The present value of an amount to be received at a specified future date is the investment that we would need to make today that, with the benefit of compound interest, would grow to the same amount as the future amount to be received at the future date.

(quoted from p. 449 on Financial and Managerial Accounting by WHBC 16th ed.)
The present value of a future cash receipt is the amount that a knowledgeable investor will pay today for the right to receive that future payment. The exact amount of the present value depends on (1) The amount of the future payment, (2) The length of time until the payment will be received, (3) The rate of return required by the investor.
The present value will always be less than the future amount, because money received today can be invested to earn interest and grow to a larger amount in the future.
Formula: P=F/(1+r)^n

Now that you understand how future and present values work, you are ready to value the zero coupon loan issued by Austral Electronics Company. In the exercise, Austral issued an 8-year $1,000,000 zero coupon. Under this, Austral will receive $466,507 at the loan inception, and pay the lender $1,000,00 in eight years’ time when the loan matures.

Although Austral will not make any interest…...

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