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Chapter 6: 14P (page 310)

At the end of 2017, Sawyer Company is conducting an impairment test and needs to develop a fair value estimate for machinery used in its manufacturing operations. Given the nature of Sawyer鈥檚 production process, the equipment is for special use. (No secondhand market values are available.) The equipment will be obsolete in 2 years, and Sawyer鈥檚 accountants have developed the following cash flow information for the equipment.

Net Cash Flow Probability Year Estimate Assessment 2018 \(6,000 40% 9,000 60% 2019 \) (500) 20% 2,000 60% 4,000 20% Scrap Value 2019 $ 500 50% 900 50%

Instructions Using expected cash flow and present value techniques, determine the fair value of the machinery at the end of 2017. Use a 6% discount rate. Assume all cash flows occur at the end of the year.

Short Answer

Expert verified

The fair value of machine at the end will be $9,672.52.

Step by step solution

01

Calculation of PV of cash flow of 2018

Presentvalueofcashflow2021=Expectedcashflow脳PVfactor=6,000脳40%+9,000脳60%脳0.9434=2,400+5,400脳0.9434=$7,358.52

02

Calculation of PV of cash flow of 2018

Presentvalueofcashflow2019=Expectedcashflow脳PV鈥�factor=-500脳20%+2,000脳60%+4,000脳20%脳0.8900=-100+1,200+800脳0.8900=$1,691

03

Computation of PV of scrap value

PVofscrapvalue=Expectedvalue脳PV鈥�factor=250+450脳0.8900=$623Fairvalueofmachinery=PV鈥�valueofexpectedcashflowof2018and2019+PVofscrapvalue=7,358.52+1,691+623=$9,672.52

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Most popular questions from this chapter

For each of the following, determine the expected cash flows. Cash Flow Probability Estimate Assessment (a) \( 4,800 20% 6,300 50% 7,500 30% (b) \) 5,400 30% 7,200 50% 8,400 20% (c) $(1,000) 10% 3,000 80% 5,000 10%

Question:Identify three situations in which accounting measures are based on present values. Do these present value applications involve single sums or annuities, or both single sums and annuities? Explain.

Question:In a book named Treasure, the reader has to figure out where a 2.2 pound, 24 kt gold horse has been buried. If the horse is found, a prize of \(25,000 a year for 20 years is provided. The actual cost to the publisher to purchase an annuity to pay for the prize is \)245,000. What interest rate (to the nearest percent) was used to determine the amount of the annuity? (Assume end-of-year payments.)

Answer each of these unrelated questions.

(a) On January 1, 2017, Fishbone Corporation sold a building that cost \(250,000 and that had accumulated depreciation of \)100,000 on the date of sale. Fishbone received as consideration a \(240,000 non-interest-bearing note due on January 1, 2020. There was no established exchange price for the building, and the note had no ready market. The prevailing rate of interest for a note of this type on January 1, 2017, was 9%. At what amount should the gain from the sale of the building be reported?

(b) On January 1, 2017, Fishbone Corporation purchased 300 of the \)1,000 face value, 9%, 10-year bonds of Walters Inc. The bonds mature on January 1, 2027, and pay interest annually beginning January 1, 2018. Fishbone purchased the bonds to yield 11%. How much did Fishbone pay for the bonds?

(c) Fishbone Corporation bought a new machine and agreed to pay for it in equal annual installments of \(4,000 at the end of each of the next 10 years. Assuming that a prevailing interest rate of 8% applies to this contract, how much should Fishbone record as the cost of the machine?

(d) Fishbone Corporation purchased a special tractor on December 31, 2017. The purchase agreement stipulated that Fishbone should pay \)20,000 at the time of purchase and \(5,000 at the end of each of the next 8 years. The tractor should be recorded on December 31, 2017, at what amount, assuming an appropriate interest rate of 12%?

(e) Fishbone Corporation wants to withdraw \)120,000 (including principal) from an investment fund at the end of each year for 9 years. What should be the required initial investment at the beginning of the first year if the fund earns 11%?

Question:What are the primary characteristics of an annuity? Differentiate between an 鈥渙rdinary annuity鈥� and an 鈥渁nnuity due.鈥�
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