Drebin Security Systems sold merchandise to a customer in exchange for a $50,000, five-year, noninterest-bearing note when an equivalent loan would carry 10% interest. Drebin would record sales revenue on the date of sale equal to:

a. $50,000.

b. Zero.

c. The future value of $50,000 using a 10% interest rate.

d. The present value of $50,000 using a 10% interest rate.

Option D. The present value of $50,000 using a 10% interest rate.

Explanation:

The reason is that the $50,000 received after a year would not be the same to the $50000 today. This is because it will devalue during this time as a result of time. This means we must discount it on the inflation rate but we have lost the chance of earning 10% which is greater than the inflation rate. This 10% is the opportunity cost for the company and it is better to use this percentage to discount the $50,000 balance receivable in a year.

Mathematically:

Present Value = Future Value / (1+r)^n

Here

Future value = $50,000

r = 10% rate of return lost

n = Cash received after 1 year

By putting values, we have:

Present Value = $50,000 / (1+10%)^1

Present Value = $45,455

D) The present value of $50,000 using a 10% interest rate.

Explanation:

When a company accepts non-interest earning notes, they must record their discounted value on their financial records. In this case, the note must be adjusted using the 10% interest that similar notes would carry:

present value = future value / (1 + r)ⁿ

present value = $50,000 / (1 + 10%)⁵ = $50,000 / 1.1⁵ = $50,000 / 1.61051 = $31,046.07 ≈ $31,046

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