EXERCISE n.

1 (15 points)
At the end of year 2008 the balance sheet of Cadyllop Inc. is the following:
ASSETS
Cash
Accounts Receivable
Short-term investments
Pre-paid expenses
Other current assets
Total current assets
Equipment
Notes receivable
Intangible assets
Total long-term assets
Total assets

LIABILITIES
Accounts Payable
Accrued Expenses Payable
Other current liabilities
Total current liabilities

850,000
150,000
120,000
30,400
10,200
1,160,600 Long term note payable
Other long-term liability
75,000
Total long-term liabilities
8,000
11,000
Total liabilities
94,000
STOCKHOLDERS EQUITY
Contributed capital
1,254,600 Retained earnings
Total stockholders equity
Total liabilities +stockholders
equity

60,000
120,000
70,000
250,000
220,000
143,500
363,500
613,500
300,000
341,100
641,100
1,254,600

The following transactions occurred in 2009:

1. On January 1 the company paid 3,600$ for a 3-year fire insurance policy. On December 31
the company must adjust the Pre-paid expenses account to reflect that one year of the policy
has expired.
2. The company estimated depreciation and amortization for equipment being 6,500$ and for
intangible assets being 1,500$.
3. On January 1 the company purchased 3,600 shares of Best Company as a long-term
investment at 25$ per share. Best Company had outstanding 30,000 shares of common
stock, par value 10$ per share. Best Company reported for the year ending the following
information: net income 50,000$ and cash dividends declared and paid during the year
25,500$. The market value of Best Company stock at the end of the year was 22$ per share.
4. The company leases a fixture from Sireland Corp. The lease is written for 20 years. The
annual payment on the lease is of 50,000$. The lease discount rate is 8%. The lease
agreement specifies that the company gets to keep the fixture at the end of the lease. The
fixture has an expected useful life of 22 years with no salvage value.
5. One intangible asset, book value=2,000$ is sold at 1,000$
6. The company paid preferred dividends in the amount of 50,300$. It declared and paid
dividends on common stock in the amount of 2$ per share. During the year the company had
50,000 shares of common stock issued.
7. The company earned sales revenues for 900,000$.
Create the T-accounts and prepare the classified balance sheet and the income statement for year
end 2009.

SOLUTION
T-accounts: balance sheet
Cash
Beg. 850,000
3,600 (1a)
90,000 (3a)
(3b)
3,060
50,000 (4c)
(5)
1,000
50,300 (6a)
100,000 (6b)***
(7)
900,000
1,460,160

Pre-paid expense
Beg. 30,400
(1a) 3,600
1,200 (1b)*

Investment in SAS
(3a) 90,000**

32,800

90,000

*Transaction 1: 3,600*1/3=1,200 to record one year of insurance policy

**Transaction 3: the company owns 12% of Best Company outstanding shares of common stock
(3,600 shares/30,000 shares), so the market value method must be applied (less than 20%
ownership).
3,600 shares*25$=90,000$ investment in SAS
25,500$*0.12=3,060$, share of dividends of Best Company due to Cadyllop Inc
3,600 shares (22$ market value-25$ cost)=-10,800$ (loss)
*** Transaction 6: 50,000 shares*2$=100,000$ of dividends paid on common stock
Lease Liability

Retained earnings
341,100 Beg

490,907 (4a)
(4c) 10,728
480,179
Equipment
Beg. 75,000
6,500 (2)
(4a) 490,907
559,407
Net unrealized loss
(3c) 10,800
10,800

(6a) 50,300
(6b) 100,000
190,800
Intangible assets
Beg. 11,000
1,500 (2)
2,000 (5)
7,500
Accumulated depreciation
22,313 (4b)
22,313

Allowance to value at
market
10,800
(3c)
10,800

T-accounts: income statement

Insurance expense
(1b) 1,200

Sales Revenues
900,000 (7)

1,200

Depr and amort expense

(2) 8,000
(4b) 22,313
30,313

900,000

Investment Income
3,060 (3b)
3,060

Interest Expense
(4c) 39,272
39,272

Unexpected losses
(5) 1,000
1,000

Lease calculation
Debit
Fixture (+A)

Credit

490,907

Lease liability (+L)

490,907

At year end (t1):

Depreciation expense (+E,-SE)

22,313
22,313

Accumulated depreciation (XA,-A)

Interest expense (+E,-SE)

39,272

Lease liability (-L)

10,728
50,000

Cash (-A)

PV of the fixture:

1
1

20
0.08 0.08(1 0.08)

PV 50,000

=490,907$
The adjustments at year end (t1):
Depreciation expense=cost-residual value*1/useful life
Depreciation expense=490,907/22=22,313$
Interest expense=490,907*0.08=39,272$
Lease liability=50,000-39,272=10,728$ (the portion of the equipment that is now owned)

Income statement
Revenues:
Total revenues

900,000

Costs and expenses:

Insurance Expense
Deprec and amortiz Expense

(1,200)
(30,313)

Operating income

868,487

Other revenues and gains

Interest expense
Unexpected losses
Investment Income

(39,272)
(1,000)
3,060

Net Income

831,275

Balance sheet
ASSETS
Cash
Accounts Receivable
Short-term investments
Pre-paid expenses
Other current assets
Total current assets
Equipment (net of
Accumulated Depreciation)
Notes receivable
Intangible assets
Investment in SAS (net of
Allowance to value at
market)
Total long-term assets
Total assets

LIABILITIES
Accounts Payable
Accrued Expenses Payable
Other current liabilities
Total current liabilities

60,000
120,000
70,000
250,000

537,094

Lease liability
Long term note payable
Other long-term liability

480,179
220,000
143,500

8,000
7,500
79,200

Total long-term liabilities

Total liabilities
STOCKHOLDERS EQUITY

843,679
1,093,679

631,794
Contributed capital
2,404,954 Retained earnings
Net unrealized loss
Total stockholders equity
Total liabilities +stockholders
equity

300,000
1,022,075
(10,800)
1,311,275
2,404,954

1,460,160
150,000
120,000
32,800
10,200
1,773,160

190,800+831,275= 1,022,075$

EXERCISE n.2 (5 points)

Flixert Company has just prepared the following financial statements for 2007.
Balance sheet, at Dec. 31, 2007
ASSETS
Cash
20,500
Accounts Receivable
13,000
Inventory
40,000
Pre-paid expenses
26,000
Property, plant and
100,000
equipment
Total assets
199,500

LIABILITIES
Accounts Payable
Income taxes payable
Note Payable, long-term
Total liabilities

48,000
15,000
30,000
93,000

STOCKHOLDERS EQUITY
Contributed capital
Retained earnings
Total stockholders equity

84,000
22,500
106,500

Total liabilities+stockholders equity

199,500

Income statement, at Dec. 31, 2007

Sales Revenues
Cost of goods sold
Gross margin
Expenses
Pre-tax income
Income tax on operations
(30%)
Income before
extraordinary items
Extraordinary loss
Net income

115,000
35,000
80,000
40,000
40,000
12,000
28,000
1,500
26,500

Calculate the current ratio and the ROA.

SOLUTION
Current assets=20,500+13,000+40,000+26,000=99,500$
Current liabilities=48,000+15,000=63,000$
Current ratio=current assets/current liabilities=99,500/63,000=1.58 to 1.00
ROA=net income/total assets=26,500/199,500=13.28%
EXERCISE n.3 (10 points)
The director of an investment fund has to evaluate the opportunity to acquire 100% of the company
Beta Corp. The shareholders of the company propose a purchasing price equal to160 million Euros.
Given the following information on Beta Corp., evaluate the opportunity to accept the offer.

Beta Corp has financial debts amounting to 30 million Euros that generate annual interest expense
for 2.4 million Euros. Beta Corp is not quoted on the stock market but the returns of a benchmark
company that is quoted on the stock market have demonstrated a covariance with the returns of the
market portfolio equal to 0.0111. This benchmark company has a financial leverage equal to 2 and a
cost of debt equal to 7%. The market portfolio has a return of 13% with a standard deviation equal
to 0.094. The market risk premium is 9%.
From the analysis of the last financial statement of Beta Corp the director of the investment fund
has calculated the presence of Levered Cash Flows (LCF) equal to 18 million Euros. The corporate
tax rate for all firms is 30%.
Assume an infinite temporal horizon and the absence of variations in cash flows during the period.
The director of the fund, on the basis of the assumption of the CAPM, should accept the offer?
SOLUTION
D=30 million Euros
Interest expenses=2.4 million Euros
LCF=18 million Euros
D/E=2 tax rate=30%
rd=7% rm=13%
rm r f 9%

i M 0.0111
M 0.094

1. Calculate rf from the formula of the risk premium

13% r f 9%
r f 4%

2. Calculate Beta

iM
0.011

1.256
2
M (0.094) 2

3. Calculate re from SML

re r f i (rM r f )
re 4% 1.256(9%) 15.3%

4. Calculate ru
D
re ru (1 Tc )(ru rd )( )
E
15.3% ru (1 30%)(ru 7%)(2)
ru 10.45%

5. Calculate the UCF and the value of the firm

UCF=LCF+Interest Expenses (1-Tax Rate)=18+(2.4*0.7)=19.68

V=UCF/ru +Tax rate*Debt=19.68/0.1045+0.3*30=197.32
197.32>160 millions, yes the offer will be accepted!