**INTEREST BEARING AND
NONINTEREST-BEARING**

**NOTES RECEIVABLE**

** **

**Present Value of a Note is
determined as follows**

** **

**1. ****Find
future cash flows. These are generally
of 2 types**

**i. Face value of note, is the amount that the
borrower will pay to the lender at the end of the loan period. It is a single sum. In a non-interest bearing note this is the
ONLY cash flow.**

** **

**ii. Cash interest payments, which are the cash
payments made by the borrower to the lender over the life of the loan. Determine the cash payments by multiplying the stated interest rate by
the stated or face value of the note.
The cash payments are the same every year.**

** **

**2. ****Discount
the future cash flows by the effective interest rate (market rate when the note
is issued).**

** **

**The single
sum from i. Above is discounted using table 2, present value of a single sum
for the given number of periods at the effective interest rate.**

** **

**The stream
of interest payments from ii. above, are an ordinary annuity (annuity in
arrears) and are discounted using the effective interest rate and the number of
periods they will be received (Table 4 gives present value factors for an
ordinary annuity). **

** **

**NOTE: if
the effective interest is equal to the stated interest the present value of the
future income stream (principal and interest payments) will equal the face
value of the note. If the stated
interest is below the market rate the note will be issued at a discount and is
said to be issued at an unrealistic interest rate. The lender will often give the borrower a low rate of interest in
order to induce the borrower to buy goods or property. Unlike bonds there is little likelihood of a
note being issued at a premium.**