Value of a Note
Response to the following problem:
You have just been promoted to manager at a national CPA firm. On your first job, a new accountant approaches you with the following situation: He has discovered that the president of the client company has a brother who is both the major stockholder and the president of a local bank. Your client has a $300,000, five-year note payable to the bank at 4% interest compounded annually. Since the going interest rate is 16%, the accountant suggests that the note be recorded at its present value using this going rate. The president says that the effective liability is $300,000 and should be reported on the balance sheet at this figure. The note was issued on January 1, 2010 and is due on January 1, 2015.
Required
1. Explain who is correct.
2. At what amount should the company have valued the note on January 1, 2010, assuming that the accountant's assessment is correct?