Question

Assume that Jimmy's Submarine Ltd. has several minor lawsuits outstanding. To determine the amount of liability to recognize on the statement of financial position, Jimmy decides to use expected cash flow techniques. Based on dicussions with their lawyers, Jimmy has developed the following cash flow estimates, and related probabilities:

Year	Cash Flow Estimate	Probability Assignment
2017	$2,300	30%
	$4,500	45%
	$8,200	25%
2018	$3,200	20%
	$5,400	50%
	$7,100	30%

Required: Based on these estimates, and assuming a risk free rate of 5%, what is the present value of expected cash flows which picnic should record on their statement of financial position for 2017?

Answer 1

Calculation of expected cash flow during 2017

Cash flow estimate (i)	Probability (ii)	Expected cash flow (i) x (ii)
2,300	30%	2,300 x 30% = 690
4,500	45%	4,500 x 45% = 2,025
8,200	25%	8,200 x 25% = 2,050
		Total = $4,765

Calculation of expected cash flow during 2017

Cash flow estimate (i)	Probability (ii)	Expected cash flow (i) x (ii)
3,200	20%	3,200 x 20% = 640
5,400	50%	5,400 x 50% = 2,700
7,100	30%	7,100 x 30% = 2,130
		Total = $5,470

Discount rate = 5%

Hence, present value of cash flows to take place in 2018 = Expected cash flows in 2018 x Present value factor (_{5%, 1})

= 5,470 x 0.952

= $5,207

Hence, expected cash flows to be shown in the statement of financial position of 2017 = Expected cash flows in 2017 + Present value of expected cash flows in 2018

= 4,765 + 5,207

= $9,972

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