# BE2 13 E2 11 CA2 1 Solutions

Pages: 6 (1444 words) Published: May 30, 2015
Kieso, Weygandt, Warfield, Young, Wiecek, McConomy

*BRIEF EXERCISE 2-13
Scenario 1: Cash flows are fairly certain
When the cash flows are fairly certain, the traditional approach works well. Under this approach, the stream of cash flows is discounted at a rate that reflects the riskiness of the cash flows. Therefore, the 6% rate would be used.

As such, the present value would be determined as follows:
PV of an annuity for 5 years at 6% = \$421.24*
*using the PV factor of 4.21236 for an ordinary annuity at 6% Scenario 2: Cash flows are uncertain
When the projected cash flows are uncertain in timing or
amount, the expected cash flow method works best. Under this approach, a risk-free rate is used to discount cash flows that have been adjusted for associated uncertainties. Additionally, this approach is more flexible when the cash flows vary over the term. As such, the present value would be determined as

follows:
PV of [(25% X \$75) + (75% X \$100)] at 3% in five years
PV of \$93.75 at 3% in five years = \$80.87 **
** using PV factor of .86261

Solutions Manual
2-18
Chapter 2

Kieso, Weygandt, Warfield, Young, Wiecek, McConomy

*EXERCISE 2-11 (15-20 minutes)
(a) At a minimum, an entity must determine
• the particular asset being measured (its condition, specific nature, location, etc.)
• whether the assets will be valued by the market as a group or on a stand-alone basis – the highest and best use that is legally, physically, and financially possible will be used
• availability of data, valuation technique to use, use of observable inputs
(b)There are three levels in the fair value hierarchy
Level 1
Level 2

Level 3

level 1 inputs provide the most reliable fair values
because these inputs are based on quoted prices in
an active market for the exact same item
level 2 is the next most reliable and considers
evaluating similar assets or liabilities in active
markets or using observable inputs such as interest
rates or exchange rates.
level 3 is the least reliable level since much judgement
is needed based on the best information available.
This often includes management judgements about
how the markets would value the asset.

Solutions Manual
2-32
Chapter 2

Kieso, Weygandt, Warfield, Young, Wiecek, McConomy

*EXERCISE 2-11 (15-20 minutes) (Continued)
(c)
Land –
standalone

Level 1- Markets for land and real estate in
general may not be very liquid nor necessarily
transparent. Also there would be little if any
evidence regarding sales of an identical piece of
land. Therefore it is likely that no level 1 inputs
are available.
Level 2 – quoted market prices for similar
properties in the area could be obtained. It
would depend on whether or not the real estate
market was experiencing sufficient volume.
Sufficient volume to form a “normal market”
would result in better information.
Level 3 – management assumptions about how
the market would value the land. In all
likelihood, the company would have to rely on
level 3 inputs to value the land, given the
uniqueness of real estate in general.

Solutions Manual
2-33
Chapter 2

Kieso, Weygandt, Warfield, Young, Wiecek, McConomy

*EXERCISE 2-11 (15-20 minutes) (Continued)
Building –
standalone

Level 1- quoted market prices do not likely exist
for the building. The market may publish
statistics such...