Question

Eagle Corporation operates under ideal conditions of certainty. It acquired its sole assets (a pen making machine) on January 1, 2020. The asset will yield $500 cash for 4 years at the end of the year; from 2020 to 2023, inclusive, after which it will have no salvage value or disposal costs. The interest rate in the economy is 4%. The purchase of the asset was financed by the issuance of common shares. Eagle Corporation will pay no dividend at the end of each year.

Required

Prepare a balance sheet AND income statement as at the end of December 31, 2020.
b. Under ideal conditions, what is the relationship between present value and market value? Explain why

Answer 1

Answer:

1)
In ideal conditions of certainty, the company's projected cash flows are capitalized as money assets. Planned earnings or cumulative discounts are merely an interest in this capitalized valuation of the asset. At any point, investors will know the anticipated profits by multiplying the opening balance sheet value of the company with the prevailing interest rate.

To prepare the balance sheet and the income statement, first calculate the present value that is to be capitalized. The current value at the onset, at the end of year 1 and at the end of year 2 is determined as follows:

Particulars	Amount	Amount
Assets:
Cas		500
Capital Asset at present value		1,387.53
Total		1,887.53
Liabilities and equity:
Sareolders equity
Capital stock		1,814.93
Retained earnins
Net Income (1,814.93*4%)		72.59
Total		1,887.53

Therefore, total assets and liabilities are: 1,887.53

The estimated income, as stated above, is merely an interest on the capitalised value of the asset. Calculate the rise in discount by combining the value of the asset with the prevailing interest rate as seen below:

Accretion of discount = 1,814.93*4%
= 72.59

2) Present value and market value are equivalent under optimal circumstances. The explanation for this is arbitration. Fair value accounting is feasible under real market conditions if accurate market values are available. However, market prices for both assets and liabilities are not available. If this is the case, the market prices of the associated assets and liabilities shall be used for financial reporting purposes. Besides that, this estimation method results in a low degree of reliability.