ACF5130 Financial statement analysis and business valuation
Introduction: Tutorial Discussion Questions
Question 1: Ideal Conditions of Accounting
BKR Ltd manufactures beach umbrellas. Its business depends upon the weather – it sells more units of beach umbrellas when the weather is hot. BKR Ltd started business on 1st January 2023. On that day, it purchased equipment to manufacture the beach umbrellas, by raising money through an equity issue. This machine has a useful life of 3 years, with no residual value. According to available forecasts of weather, the weather is certain to be hot in 2023 and there is a 0.65 probability of hot weather in 2024 and 2025. The following table provides expected cash flows for hot weather and cold weather respectively.
Assume that the discount rate is 10%. The actual weather in both 2024 and 2025 were hot. Using this information, estimate:
(i) The net income for the year ended 31st December 2023.
(ii) The value of BKR Ltd’s assets as at 31st December 2023.
Question 2: Ideal Conditions of Accounting
One of the potential benefits of fair values is that they represent the current exit price – the price at which an asset may be exchanged or liability transferred between knowledgeable parties at an arm’s length transaction. For assets and liabilities with active markets, the fair value is the current market price. Assume that all assets and liabilities have active markets. Can investors earn abnormal returns if all assets and liabilities were measured at fair value? Assume that the market is semi-strong form. efficient and use your understanding of accounting under non-ideal conditions to answer the question.
Question 3: Ideal Conditions of Accounting
Net income is absolutely unbiased under ideal conditions of accounting but has no information content. Explain why this is so. Can traders earn abnormal returns by trading under ideal conditions of accounting? Explain your response.