Solution Manual for Stice IA,18Edition 2012

Solution Manual for Stice IA,18Edition 2012

Fair Value Module
An Excel spreadsheet that contains the details of the calculations for the Fair Value
Module solutions is available on the IRCD and instructor Web site.
EXERCISES
FV–1. Building 3
• Look at the 7% capitalization rate row.
• Based on square footage, Building 3 is 80% of the way from
$2,000,000 to $2,500,000.
• Estimated fair value of Building 3 = $2,400,000 = $2,000,000 +
0.8($2,500,000 – $2,000,000)
Building 4
• Look at the 8% capitalization rate row.
• Based on square footage, Building 4 is 10% of the way from
$2,250,000 to $2,625,000.
• Estimated fair value of Building 4 = $2,287,500 = $2,250,000 +
0.1($2,625,000 – $2,250,000)
Building 5
• Look at the 10% capitalization rate row.
• Based on square footage, Building 5 is 60% of the way from
$1,800,000 to $2,100,000.
• Estimated fair value of Building 5 = $1,980,000 = $1,800,000 +
0.6($2,100,000 – $1,800,000)
FV–2. Selling Price
Square Feet
Capitalization Rate 10,000 20,000 30,000 40,000 50,000
7%…………………… $700,000 $1,425,000 $2,000,000 $2,500,000 $3,000,000
8%…………………… 625,000 1,250,000 1,750,000 2,250,000 2,625,000
9%…………………… 550,000 1,100,000 1,550,000 2,000,000 2,300,000
10%…………………… 500,000 1,000,000 1,400,000 1,800,000 2,100,000
9.3%…………………… 535,000 1,070,000 1,505,000 1,940,000 2,240,000
Building Z
• Look at the 9.3% capitalization rate row which was created by
interpolation between the 9% and 10% rows.
• Based on square footage, Building Z is 20% of the way from
$1,505,000 to $1,940,000.
• Estimated fair value of Building Z = $1,592,000= $1,505,000 +
0.2($1,940,000 – $1,505,000)
FV-2 Fair Value Module
FV–3.
• Look at the AA bond rating column.
• Based on the term of the bond, the bond is 30% of the way from 100 to
91.
• 100 – (0.3 × 9) = 97.3
• Estimated fair value of the bond = 0.973 × $1,000 = $973
FV–4. Bond 3
• Look at the AAA bond rating column.
• Based on the term of the bond, Bond 3 is one-third of the way from
103.85 to 103.66.
• Estimated bond price as a percent of par = 103.787 = 103.85 –
1/3(103.85 – 103.66)
• Estimated price of Bond 3 = 1.03787 × $1,000 = $1,037.87
Bond 4
• Look at the BB bond rating column.
• Based on the term of the bond, Bond 4 is 80% of the way from 91.98 to
82.06.
• Estimated bond price as a percent of par = 84.044 = 91.98 – 0.8(91.98 –
82.06)
• Estimated price of Bond 4 = 0.84044 × $1,000 = $840.44
Bond 5
• Look at the A bond rating column.
• Based on the term of the bond, Bond 5 is 80% of the way from 101.45
to 99.56.
• Estimated bond price as a percent of par = 99.938 = 101.45 –
0.8(101.45 – 99.56)
• Estimated price of Bond 5 = 0.99938 × $1,000 = $999.38
FV–5. Customer List
Outcome 1: PMT = $40,000; I = 8%; N = 5 years → $159,708
Outcome 2: PMT = 18,000; I = 8%; N = 4 years → 59,618
Outcome 3: PMT = 9,000; I = 8%; N = 3 years → 23,194
Present Probability-Weighted
Value Probability Present Value
Outcome 1……….. $159,708 0.20 $31,942
Outcome 2……….. 59,618 0.30 17,885
Outcome 3……….. 23,194 0.50 11,597
Total estimated fair value……………………….. $61,424
Fair Value Module FV-3
FV–5. (Concluded)
Franchise Agreement
Outcome 1: PMT = $450,000; I = 8%; N = 10 years → $3,019,537
Outcome 2: PMT = 12,000; I = 8%; N = 4 years → 39,746
Outcome 3: PMT = 500; I = 8%; N = 3 years → 1,289
Present Probability-Weighted
Value Probability Present Value
Outcome 1……….. $3,019,537 0.10 $301,954
Outcome 2……….. 39,746 0.20 7,949
Outcome 3……….. 1,289 0.70 902
Total estimated fair value……………………….. $310,805
FV–6. The fair value of the business license is $42,979, computed as follows:
Discount rate……………………………………………… 15.0%
Royalty rate……………………………………………….. 2.0%
Initial annual cab revenue growth rate………… 10.0%
Terminal growth rate (after five years)………… 3.0%
Income tax rate ………………………………………….. 30%
Growth 3%
Year 1 Year 2 Year 3 Year 4 Year 5 Years 5+
Total annual revenue … $ 300,000 $ 330,000 $ 363,000 $ 399,300 $ 439,230
Pretax royalty (2%)……. $ 6,000 $ 6,600 $ 7,260 $ 7,986 $ 8,785
Income taxes (30%)…… 1,800 1,980 2,178 2,396 2,636
After-tax royalty………… $ 4,200 $ 4,620 $ 5,082 $ 5,590 $ 6,149 $52,779
Discounted cash flow .. $ 3,652 $ 3,493 $ 3,341 $ 3,196 $ 3,057
Sum of discounted cash flow………………….. $ 16,739
Present value of “perpetuity”………………….. 26,240
Total present value of cash flows……………. $ 42,979
FV–7. We can estimate a “depreciated” replacement cost using a process
exactly analogous to the computation of depreciated book value. The
computations are as follows:
• ($800,000 – $40,000) ÷ 16 years = $47,500 “depreciation” per year
• 7 years × $47,500 “depreciation” per year = $332,500 total
“depreciation”
• $800,000 replacement cost new – $332,500 “depreciation” = $467,500
adjusted replacement cost
This $467,500 adjusted replacement cost is a cost-based estimate of the
fair value of the rock crushing system. If it is more reasonable to assume
that the system loses value more quickly in the early years, then an
accelerated depreciation method can be used.
FV-4 Fair Value Module
FV–8. Note: These securities are reported at fair value on a recurring basis.
Fair Value Measurements at Reporting Date Using
Quoted Prices
in Active Significant
Markets for Other Significant
Identical Observable Unobservable
Assets Inputs Inputs
Description Total (Level 1) (Level 2) (Level 3)
Trading securities……………. $27,000 $27,000
Available-for-sale securities 35,340 $29,340 $6,000
Total ……………………………….. $62,340 $27,000 $29,340 $6,000
Fair Value Measurements Using
Significant Unobservable Inputs
(Level 3)
Real Estate
Investment Trust
Security 3
Beginning balance……………………………………………….. $ 5,400
Total gains or losses (realized/unrealized)
Included in earnings ………………………………….. 0
Included in other comprehensive income …… (2,600)
Purchases………………………………………………………. 3,200
Transfers in or out of Level 3…………………………… 0
Ending balance ……………………………………………………. $ 6,000
The unrealized decrease of $2,600 recognized in other comprehensive
income this year is computed as follows:
Beginning of Year Ending of Year
Market Market
Securities Cost Value Cost Value
First purchase…………………………. $ 4,500 $ 5,400 $ 4,500 $ 3,600
Second purchase…………………….. 0 0 3,200 2,400
Total ……………………………………….. $ 4,500 $ 5,400 $ 7,700 $ 6,000
Cumulative unrealized gain or
loss at the beginning of year ($5,400 – $4,500) Unrealized gain $900
Cumulative unrealized gain or
loss at the end of Year 2 ($6,000 – $7,700) Unrealized loss $1,700
To get from a cumulative unrealized gain of $900 to a cumulative
unrealized loss of $1,700 required an UNREALIZED LOSS of $2,600 for
the year.