[Oimie]

NINJA Question –

Can someone explain to me what is going on in this story? I am fine with the calculations but the problem is I do not understand what is actually happening in the story. What does it mean when they say that Kay undiscounted the note at a bank? Does this mean Kay sold the note to the bank and the bank will be the one receiving $55,000? Kay should’ve earned $2,500 of interest by July 1 X2, but only received 1,700. How does the 12% relate to this $800 reduction?

On July 1, Year 1, Kay Corp. sold equipment to Mando Co. for $100,000. Kay accepted a 10% note receiv­able for the entire sales price. This note is payable in two equal installments of $50,000 plus accrued interest on December 31, Year 1 and Year 2. On July 1, Year 2, Kay discounted the note at a bank at an interest rate of 12%. Kay’s proceeds from the discounted note were:

A. $48,400.

B. $49,350.

C. $50,350.

D.$51,700.

Answer is D.

And this is their explanation which I do not understand, story wise.

When accounting for a discounted note and computing the cash proceeds, one must first find the maturity value of the note, what will be received by the holder of the note when it comes due.

By the time of the discounting, some of the principal has already been paid. Only the second installment, the final $50,000 principal plus interest, will be paid to the bank when due.

At the end of December, Year 2, the $50,000 will be received by the bank along with 10% interest (since the principal will have been outstanding for a whole year). On December 31, Year 2, a total of $55,000 maturity value will be due:

$50,000 + ($50,000 × 0.1) = $55,000

The discounted proceeds will be based on this amount, the discount rate (0.12), and the discounting period (from July to December of Year 2, 6 months). The discount amount is thus:

$55,000 × 0.12 × 6/12 = $3,300

The cash proceeds are the maturity value less the discount:

$55,000 – $3,300 = $51,700

FAR 85 June 2015
AUD 80 Nov 2015
REG 83 Nov 2015
BEC 79 Feb 2016

[Skynet]

Kay corp CEO needing cash for his gambling problem and to pay alimony to his exwife needed immediate cash sold the note to the bank. To top it off visits to his local gentlemen's cost is not cheap.

[tuanxn]

Hey Oimie, let me see if I can try and explain this..

Kay did sell the note to the bank at a discount rate of 12%, which means that 12% will be deducted from the amount due to Kay. They calculated that the period from Jan 1 to Dec 31 Year 2 would result in $55,000 due, but since the note was sold halfway through the year on July 1st; we must deduct only 6% of that amount.

Thus $55,000 x 6% = $3300

$55,000 – $3300 = $51,700 cash proceeds

[Oimie]

@Skynet: Bro I was ready to go make myself some popcorn when I realized the story ended.

@tuanxn: Thanks for clarifying although I still didn't understand your explanation when it came to the numbers. xD

But I think I finally got it. So is it like this?

On July 1 X2, it's as if Kay sold a $55,000 12% note to the bank.

So at maturity date the bank “should” have received a total of 55,000 + 3,300 interest.

But the bank really only gets paid $55,000 from Mando.

So the bank charges the 3,300 from Kay's $55,000.

FAR 85 June 2015
AUD 80 Nov 2015
REG 83 Nov 2015
BEC 79 Feb 2016

[Author]

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