Financial Accounting Theory Ch Partial Solutions
2ACCT 455 CHAPTER 2 Solutions
2.
Suppose that P.V. Ltd. paid a dividend of $10 at the end of year 1 (any portion of year 1 net income would do). Then, its year 2 opening net assets are $276.36, and net income would be: P.V. Ltd. Income Statement For Year 2 Accretion of discount (10% × 276.36) P.V.’s balance sheet at time 2 would be: P.V. Ltd. Balance Sheet As at Time 2 $27.64
Financial Asset Cash: (140 + 14 + 150) $304.00
Shareholders’ Equity Opening Balance: 276.36 (286.36 - 10.00 dividend)
Capital Asset, at Present value 0.00 $304.00
Net income 27.64
$304.00
Thus, at time 2 the shareholders have: Cash from dividend Interest at 10% on cash dividend, for year 2 Value of firm per balance sheet $10.00 1.00 304.00 $315.00
Copyright © 2012 Pearson Canada Inc
1
This is the same value as that of the firm at time 2, assuming P.V. Ltd. paid no dividends (see Question 1). Consequently, the firm’s dividend policy does not matter to the shareholders under ideal conditions. It may be worth noting that a crucial requirement here, following from ideal conditions, is that the investors and the firm both earn interest on financial assets at the same rate. 3. Year 1 At time 0, you know that if the bad economy state is realized, ex post net income for year 1 will be a loss of $23.97. If the good economy state is realized, ex post net income will be $76.03. Since the probability of each state is 0.50, expected net income for year 1, evaluated at time 0, is:
0.50 (-23.97) + 0.50 (76.03) = -11.98 + 38.01 = $26.03. This agrees with the direct calculation of accretion of discount for year 1 in Example 2.2. Year 2 Assume that you are at time 1, after the state realization for year 1 has been observed. Suppose the year 1 state realization is bad economy. Then expected net income for year 2 is accretion of discount on opening net asset value of $236.36: 236.36 × .10 = 23.64 Note that this amount includes $10 interest on opening cash balance of $100. Now
2.
Suppose that P.V. Ltd. paid a dividend of $10 at the end of year 1 (any portion of year 1 net income would do). Then, its year 2 opening net assets are $276.36, and net income would be: P.V. Ltd. Income Statement For Year 2 Accretion of discount (10% × 276.36) P.V.’s balance sheet at time 2 would be: P.V. Ltd. Balance Sheet As at Time 2 $27.64
Financial Asset Cash: (140 + 14 + 150) $304.00
Shareholders’ Equity Opening Balance: 276.36 (286.36 - 10.00 dividend)
Capital Asset, at Present value 0.00 $304.00
Net income 27.64
$304.00
Thus, at time 2 the shareholders have: Cash from dividend Interest at 10% on cash dividend, for year 2 Value of firm per balance sheet $10.00 1.00 304.00 $315.00
Copyright © 2012 Pearson Canada Inc
1
This is the same value as that of the firm at time 2, assuming P.V. Ltd. paid no dividends (see Question 1). Consequently, the firm’s dividend policy does not matter to the shareholders under ideal conditions. It may be worth noting that a crucial requirement here, following from ideal conditions, is that the investors and the firm both earn interest on financial assets at the same rate. 3. Year 1 At time 0, you know that if the bad economy state is realized, ex post net income for year 1 will be a loss of $23.97. If the good economy state is realized, ex post net income will be $76.03. Since the probability of each state is 0.50, expected net income for year 1, evaluated at time 0, is:
0.50 (-23.97) + 0.50 (76.03) = -11.98 + 38.01 = $26.03. This agrees with the direct calculation of accretion of discount for year 1 in Example 2.2. Year 2 Assume that you are at time 1, after the state realization for year 1 has been observed. Suppose the year 1 state realization is bad economy. Then expected net income for year 2 is accretion of discount on opening net asset value of $236.36: 236.36 × .10 = 23.64 Note that this amount includes $10 interest on opening cash balance of $100. Now