Financial Accounting and Reporting-CPA Practice Exam

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What time value of money concept applies when a payment for a machine is due in two years?

  1. Future value of a lump-sum payment.

  2. Present value of an annuity.

  3. Present value of a lump-sum payment.

  4. Future value of an annuity.

The correct answer is: Present value of a lump-sum payment.

The appropriate application of the time value of money concept for a payment due in the future is present value of a lump-sum payment. This concept reflects the value today of a payment that will be received or made at a future date, considering the interest rates or return on investment that could be earned over the period until that payment is actually made. In the context of a machine payment due in two years, one would want to determine how much that future payment is worth in today’s terms. This involves discounting the future amount back to its present value using a specific discount rate. By doing this, the analysis allows one to understand how much the future payment is effectively valued today, considering the opportunity cost of money, inflation, or other financial factors. Other concepts listed, such as future value or annuities, do not apply appropriately to this scenario. The future value of a lump-sum payment looks at how much a current amount of money will grow in the future rather than the reverse. Furthermore, present value of an annuity is focused on a series of equal payments made at regular intervals rather than a single payment, which is the case here. Future value of an annuity has a similar misalignment since it deals with multiple future payments rather