KIKI CORPORATION

Kiki Corporation, a US company, prepares its financial statements under US GAAP. For 2014, the company reported $1,000,000 income and stockholders’ equity balance of $8,000,000 on December 31, 2014. In preparation for a possible adoption of IFRS by the US companies, the management wishes to explore possible impacts of the move. You are engaged to prepare a reconciliation schedule to convert 2014 income as well as stockholders’ equity on December 31, 2014 from US GAAP basis to IFRS. The following information is provided by the company’s accounting department:

1. In 2010, the company acquired a brand with a fair value of $50,000. The brand was booked as an intangible asset with an indefinite life. At the end of 2014, the brand had a selling value of $46,000 with zero selling expense. Expected future cash flows from continued use of the brand are $52,000 and the present value of the expected future cash flows is $43,000.
2. In 2014, Kiki Corporation incurred research and development costs of $200,000. Of this amount, 45% related to development activities subsequent to the point at which criteria had been met indicating that an intangible asset existed. As of the end of 2014, development of the new product had not been completed.
3. At the end of 2014, Kiki Corporation had an inventory item with a historical cost of $250,000, a replacement cost of $170,000, a net realizable value of $190,000, and a normal profit margin of 20 percent.
4. In January 2012, the company realized a gain on the sale-and-leaseback of an office building in the amount of $150,000. The lease is accounted for as an operating lease, and the term of the lease is five years.
5. The company acquired a building at the beginning of 2013 at a cost of $2,750,000. The building has an estimated useful life of 25 years, an estimated residual value of $500,000, and is being depreciated on a straight-line basis. At the beginning of 2014, the building was appraised and determined to have a fair value of $3,250,000. There is no change in estimated useful life or residual value. In a switch to IFRS, the company would use revaluation model in IAS 16 to determine the carrying value of property, plant, and equipment subsequent to acquisition.

Make sure your reconciliation statement is accompanied by an adequate explanation and reference for every one of your adjustments. Ignore income taxes.

CASE ONE, KIKI CORPORATION

Kiki Corporation, a US company, prepares its financial statements under US GAAP. For 2014, the company reported $1,000,000 income and stockholders’ equity balance of $8,000,000 on December 31, 2014. In preparation for a possible adoption of IFRS by the US companies, the management wishes to explore possible impacts of the move. You are engaged to prepare a reconciliation schedule to convert 2014 income as well as stockholders’ equity on December 31, 2014 from US GAAP basis to IFRS. The following information is provided by the company’s accounting department:

In 2010, the company acquired a brand with a fair value of $50,000. The brand was booked as an intangible asset with an indefinite life. At the end of 2014, the brand had a selling value of $46,000 with zero selling expense. Expected future cash flows from continued use of the brand are $52,000 and the present value of the expected future cash flows is $43,000.

In 2014, Kiki Corporation incurred research and development costs of $200,000. Of this amount, 45% related to development activities subsequent to the point at which criteria had been met indicating that an intangible asset existed. As of the end of 2014, development of the new product had not been completed.

At the end of 2014, Kiki Corporation had an inventory item with a historical cost of $250,000, a replacement cost of $170,000, a net realizable value of $190,000, and a normal profit margin of 20 percent.

In January 2012, the company realized a gain on the sale-and-leaseback of an office building in the amount of $150,000. The lease is accounted for as an operating lease, and the term of the lease is five years.

The company acquired a building at the beginning of 2013 at a cost of $2,750,000. The building has an estimated useful life of 25 years, an estimated residual value of $500,000, and is being depreciated on a straight-line basis. At the beginning of 2014, the building was appraised and determined to have a fair value of $3,250,000. There is no change in estimated useful life or residual value. In a switch to IFRS, the company would use revaluation model in IAS 16 to determine the carrying value of property, plant, and equipment subsequent to acquisition.

Make sure your reconciliation statement is accompanied by an adequate explanation and reference for every one of your adjustments. Ignore income taxes.

On November 1, 2014, Moddel Company (a U.S. corporation) entered into a 90-day forward contract to purchase 200,000 British pounds. The purpose of the forward contract is to hedge a commitment to purchase special equipment on January 30, 2015 from a British firm Jeckyl, Inc. The invoice price on the purchase commitment is denominated in British pounds. The forward contract is not settled net. Assume Moddel uses a 12% interest rate. Use a fair value hedge.

The relevant exchange rates are stated in dollars per pound:

                                                                        Forward Rate
                                             Spot Rate         to Jan. 30, 2012
November 1, 2014                      $1.32                    $1.35
December 31, 2014                    $1.47                    $1.50
January 30, 2015                        $1.55                           -

Part 1:  What journal entry did Moddel record on November 1, 2014?

Part 2:  What journal entries did Moddel record on December 31, 2014?

Part 3:  What journal entries did Moddel record on January 30, 2015 if the purchase was made?

Homework 5

3-month put option on Euro at 1.25% Premium ($/€)                                                                                     $1.4220

Natural Mosaic Company (U.S.) is considering investing Rs50,000,000 in India to create a wholly owned tile manufacturing plant to export to the European market. After five years, the subsidiary would be sold to Indian investors for Rs100,000,000. A pro forma income statement for the Indian operation predicts the generation of Rs7,000,000 of annual cash flow, is listed in the following table.

Sales revenue    30,000,000

Less cash operating expenses (17,000,000)

   ----------------

Gross income 13,000,000

Less depreciation expenses (1,000,000)

   ---------------

Earnings before interest and taxes 12,000,000

Less Indian taxes at 50%    (6,000,000)

-----------------

Net income 6,000,000

Add back depreciation 1,000,000

   -------------

Annual cash flow 7,000,000

The initial investment will be made on December 31, 2011, and cash flows will occur on December 31st of each succeeding year. Annual cash dividends to Philadelphia Composite from India will equal 75% of accounting income. The U.S. corporate tax rate is 40% and the Indian corporate tax rate is 50%. Because the Indian tax rate is greater than the U.S. tax rate, annual dividends paid to Natural Mosaic will not be subject to additional taxes in the United States. There are no capital gains taxes on the final sale. Natural Mosaic uses a weighted average cost of capital of 14% on domestic investments, but will add six percentage points for the Indian investment because of perceived greater risk. Natural Mosaic forecasts the rupee/dollar exchange rate for December 31st on the next six years are listed below.

R$/$    R$/$   

(2011) 50    (2014) 62

(2012) 54 (2015)    66

(2013) 58 (2016)    70

What is the net present value and internal rate of return on this investment?

Comment:

1. You have to do this problem from the viewpoint of the parent.

Thank you,

13) Trident — the same U.S.-based company discussed in this chapter, has concluded a second larger sale of telecommunications equipment to Regency (U.K.). Total payment of £2,000,000 is due in 90 days. Given the following exchange rates and interest rates, which of the following statements about option hedge is correct?

Select one:

a.Buy put options of £2,000,000 with strike of $1.54/£ and receive a (net) minimum of $3,052,116.33 at end of 90 days.

b.Sell put options of £2,000,000 with strike of $1.54/£ and receive a (net) minimum of $3,048,077.55 at end of 90 days.

c.Sell put options of £2,000,000 with strike of $1.55/£ and receive a (net) minimum of $3,052,116.33 at end of 90 days.

d.Buy put options of £2,000,000 with strike of $1.55/£ and receive a (net) minimum of $3,048,077.55 at end of 90 days.

e.Buy put options of £2,000,000 with strike of $1.55/£ and receive a (net) minimum of $3,052,116.33 at end of 90 days.

Trident — the same U.S.-based company discussed in this chapter, has concluded a second larger sale of telecommunications equipment to Regency (U.K.). Total payment of £2,000,000 is due in 90 days. Given the following exchange rates and interest rates, which of the following statements about option hedge is correct?

Select one:

Sell put options of £2,000,000 with strike of $1.55/£ and receive a (net) minimum of $3,052,116.33 at end of 90 days.

Buy put options of £2,000,000 with strike of $1.55/£ and receive a (net) minimum of $3,048,077.55 at end of 90 days.

Buy put options of £2,000,000 with strike of $1.55/£ and receive a (net) minimum of $3,052,116.33 at end of 90 days.

Buy put options of £2,000,000 with strike of $1.54/£ and receive a (net) minimum of $3,052,116.33 at end of 90 days.

Sell put options of £2,000,000 with strike of $1.54/£ and receive a (net) minimum of $3,048,077.55 at end of 90 days.

1. A U.S. company expects to pay 1 million Euros in six months. How can they use forward contracts to hedge against the exchange rate risk? 2. The price of gold is currently $660 per ounce. The forward price for delivery in one year is $700. An arbitrage trader can borrow or lend money at 10% per annum. Identify an arbitrage strategy. 3. A trader owns one unit of gold. The trader can buy gold at $50 per ounce and sell it at $40 per ounce in the spot market. She can borrow money at 6% per year and can invest money at 5% per year. For what range of one-year gold forward price F does this trader have no arbitrage opportunities?

Xiling Co. is a U.S. company with sales to Canada amount­ing to C$8 million. Its cost of materials attributable to the purchase of Canadian goods is C$6 million. Its interest expense on Canadian loans is C$4 million. Given these exact figures above, the dollar value of Whitewater’s “earnings before interest and taxes” would _______ if the Canadian dollar appreciates; the dollar value of Whitewater’s cash flows would _______ if the Canadian dollar appreciates.

                                                                                                               Analytical Application

                                                                                                    Using International Financial Markets

Worcester Tool Company is a large, U.S.-based, multinational corporation with subsidiaries in eight different countries. The parent of Worcester provided an initial cash infusion to establish each subsidiary. Each subsidiary, however, has had to finance its own growth since then. The parent and subsidiaries of the firm typically use Citigroup (with branches in numerous countries) when possible to facilitate any flow of funds necessary.

a. Explain the various ways in which Citigroup could facilitate Worcester’s flow of funds, and identify the type of financial market where that flow of funds occurs. For each type of financing transaction, specify whether Citigroup would serve as the creditor or would simply facilitate the flow of funds to the firm.

b. Recently, the British subsidiary called on Citigroup for a medium-term loan and was offered the following alternatives.

LOAN DENOMINATED IN                                       ANNUALIZED RATE

British pounds    13%

U.S. dollars                                                                    11%

Canadian dollars                                                          10%

Japanese yen                                                                  8%