Question

Question 2.1                                                                                                          (Total: 30 marks)

Blue Ocean Ltd. owns a 25% common share interest in Red Ocean Ltd. Blue Ocean acquired the shares nine years ago through a financing transaction. Each year, Blue Ocean has received a dividend from Red Ocean. Red Ocean has been in business for 50 years and continues to have strong operations and cash flows. Blue Ocean must determine the fair value of this investment at its year end. Since there is no market on which the shares are traded, Blue Ocean must use a discounted cash flow model to determine fair value.

Blue Ocean management intends to hold the shares for five more years, at which time they will sell the shares to a shareholder of Red Ocean under an existing agreement for $1 million. There is no uncertainty in this amount. Management expects to receive dividends of $80,000 for each of the five years, although there is a 20% chance that dividends could be $50,000 each year. The risk-free rate is 4% and the risk-adjusted rate is 6%.

Required:

1.      List 3 items that Blue Ocean will need to consider in determining the fair value of the investment.

2.      Calculate the fair value of the investment in Red Ocean using the traditional approach. Hint: To support you in your calculation, the factor tables are located in Appendix A at the back of your textbook. You will need to use table PV.1 and PV.2 for this calculation.

3.      Calculate the fair value of the investment using the expected cash flow approach.

Question 2.2                                                                                                                      (Total: 14 marks)

Alpha Corporation is preparing a contract to lease a machine from Beta Corporation for a period of 25 years. Alpha has an investment cost of $365,755 in the machine, which has a useful life of 25 years and no salvage value at the end of that time. Alpha is interested in earning an 11% return on its investment and has agreed to accept 25 equal rental payments at the end of each of the next 25 years.

Alpha Corporation has asked you to provide the amount of each of the 25 rental payments that will yield an 11% return on investment. You may use the factor table A.4 in appendix A, or a financial calculator or Excel’s PV function to complete the calculation.

Question 2.3                                                                                                      (Total: 18 marks; 2 marks each)

Financial information follows for four different companies:

Ace Consulting Inc.

Brrrr Freezers Corp.

Capital Consumer   Inc.

Death Star Ltd.

Sales Revenue

$98,000

(c)

$144,000

$120,000

Sales Returns and Allowances

 (a)

$  5,000

12,000

9,000

Net Sales Revenue

74,000

 101,000

132,000

   (g)

Beginning Inventory

21,000

(d)

 44,000

 24,000

Purchases

63,000

105,000

 (e)

90,000

Returns and Allowances

6,000

10,000

 8,000

  (h)

Ending Inventory

 (b)

48,000

30,000

 28,000

Cost of Goods Sold

64,000

72,000

(f)

72,000

Gross Profit

10,000

29,000

18,000

(i)

Required

1.      Determine the missing amounts for parts (a) to (i). Show all calculations.

Question 2.4                                                                                           (Total: 20 marks; -2 marks per error)

The following is a trial balance from Mismanaged Ltd. on March 31, 2020 is as follows:

Debit

Credit

Cash

$ 2,870

Accounts receivable

3,231

Office supplies

800

Equipment

3,800

Accounts payable

$ 2,666

Unearned revenue

1,200

Common shares

6,000

Retained earnings

2,795

Service revenue

2,380

Salaries and wages expense

3,400

Office expense

940

TOTAL

$ 15,041

$15,041

The following transactions took place in April 2020:

·        Payments received from customers on account amounted to $1,320.

·        A computer printer was purchased on account for $500.

·        Services provided to clients and billed on account amounted to $3,890.

·        $400 of supplies was purchased on account in April, and a physical count on April 31 showed that there was $475 of supplies on hand on April 31.

·        When the Unearned Revenue account was reviewed, it was found that $825 of the balance was earned in April.

·        Salaries and Wages Expense of $670 related to employee services provided in April was not yet recorded as at April 31 (will be paid in May).

·        Payments to suppliers on account amounted to $2,125.

·        Received invoices totaling $1,160 related to office expenses incurred in April.

·        Declared a dividend of $575 on April 31.

Required:

1.      Prepare the trial balance as at April 30, 2020, assuming that Mismanaged did not record closing entries at the end of March 2020. (Hint: It may be necessary to add one or more accounts to the trial balance.)

Question 2.5                                                                                                                      (Total: 18 marks)

Spin Corporation manufacturers cycling equipment for fitness classes. Recently, the company’s Executive VP of Operations requested construction of a new plant to meet the increasing demand for the company’s workout bikes. After considering the request, the BOD has decided to raise funds for the new plant by issuing $2,000,000 of 11% term corporate bonds on March 1, 2021, due on March 1, 2035, with interest payable each March 1 and September 1. At the time of issuance, the market interest rate for similar financial instruments is 10%.

Required:

1.      Determine the selling price of the bonds. You may use the factor tables A.2 and A.4 in appendix A, or a financial calculator or Excel’s PV function to complete the calculation.

2.      What is the basis of measurement for the bond?

Answer 1

Q1 :

Q 2 :

Q3 :