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On December 31, Year One, Ace signs a lease to use a truck forfour years. The truck has a current value of $58,600. Four annualpayments of $10,000 are to be paid with the first made on December31, Year One. After that time, the truck (with an expected life ofeight years) will be returned to the lessor. Ace has an incrementalborrowing rate of 6 percent. The lessor has an implicit annualinterest rate of 8 percent built into the contract. Ace is aware ofthis implicit rate. The present value of a four-year annuity due of$10,000 at a 6 percent annual rate is $36,700. The present value ofa four-year annuity due of $10,000 at an 8 percent annual rate is$35,770. What liability should Ace report on its December 31, YearOne, balance sheet?

a.$0

b.$10,000

c.$25,770

d.26,700

2.On January 1, Year One, theLenoir Company leases equipment from Burke Corporation for eightyears which is the entire life of the asset. It will be discardedat the end of that period. For Burke, this transaction is a directfinancing leases using an implicit interest rate of 10 percent.Based on that rate, the annual payments are $12,000 beginningimmediately. Lenoir is unaware of Burke's implicit but has anincremental borrowing rate of 8 percent. Assume that the presentvalue of an ordinary annuity for eight years at an annual interestrate of 8 percent is 5.75 and at 10 percent is 5.33 whereas thepresent value of an annuity due for eight years at an annualinterest rate of 8 percent is 6.21 and at 10 percent is 5.87. Ifthe effective rate method is applied, what amount of interestexpense should Lenoir report for Year Two? (Round to the nearestdollar.)

a.$4,089

b.$4,442

c.$4,516

d.$5,070

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Sixta Kovacek
Sixta KovacekLv2
28 Sep 2019

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1. Assume you started a new business last year with $50,000 ofyour own money that was used to purchase equipment. Now you areseeking a $25,000 loan to finance the inventory needed to reachthis year’s sales target. You have agreed to pledge your venture’sdelivery truck and your personal automobile as support for theloan. Your sister also has agreed to cosign the loan. During yourinitial year of operation, you paid your suppliers in a timelyfashion.

1A. Analyze the loan request from theviewpoint of a lender who uses the “five Cs” of credit analysis asan aid in deciding whether to make loans.

1B. Assume you arecurrently carrying an accounts receivable balance of $10,000. Howmight you use accounts receivables to obtain an additional bankloan?

1C. Assume at the end ofnext year, you will have an accounts receivable balance of $15,000and an inventories balance of $30,000. If a bank normally lends anamount equal to 80 percent of accounts receivable and 50 percent ofinventories pledged as collateral, what would be the amount of abank loan a year from now?

2. The BETA firm is proposing to acquire the ACE Productsventure described in Problem 1. BETA estimates that ACE’s free cashflow for next year could be improved to $5.5 million because ofsynergistic benefits in the form of operating or distributioneconomies. The potential acquirer also believes that ACE’sperpetuity growth rate could be increased to 7 percent annually.However, the riskiness of the cash flows would be increased causingthe appropriate WACC to increase to 16 percent. Interest-bearingdebt owed by ACE is $17.5 million. In addition, the venture alsohas surplus cash of $4 million. ACE Products has five millionshares of common stock outstanding.

2A. Determine ACE’senterprise value from the perspective of BETA. What isACE’s equity worth to BETA in dollar amount and on a per sharebasis?

2B. Use the per share valueof ACE from Problem 1 and the per share value from this problem andestablish a range of values (i.e., without and with expectedsynergistic benefits). If one-half of the synergy derived benefitswere allocated to ACE’s venture investors and founders, what priceper share would the merger take place?

2C. BETA has thirty million shares ofstock outstanding with a market capitalization value of $600million. What is BETA’s stock price? Determine the exchange ratiobetween ACE’s stock value and BETA’s stock price at each of ACE’svalues established in Part B. That is, what would ACE’s ventureinvestors and founders receive in BETA’s shares for each share ofcommon stock they currently hold in ACEProducts?

On December 31, Year One, a company leases equipment for 8years, its entire life. Payments are $10,000 per year on December31 with the first one made immediately. The present value of thesepayments at the lessee's incremental borrowing rate of 10 percentper year is assumed to be $58,000. On the December 31, Year Onebalance sheet, what should this lessee report as its currentliability for this lease?

a.$0

b.$5,200

c.$6,000

d.$10,000

On January 1, Year One, a company leases equipment for 8 yearsalthough the equipment has a life of 10 years. At the end of thattime, title to this property will be conveyed to the lessee.Payments are $10,000 per year on January 1 with the first one madeimmediately. The present value of these payments at the lessee'sincremental borrowing rate of 10 percent per year is assumed to be$58,000. What amount of depreciation expense should the lesseerecognize for Year One?

a.$0

b.$5,800

c.$6,000

d.$7,250

The County of Maxnell decides to create a sanitation departmentand offer its services to the public for a fee. As a result, countyofficials plan to account for this activity within the enterprisefunds. Make journal entries for this operation for the following2015 transactions as well as necessary adjusting entries at the endof the year. Assume that the information is being gathered for fundfinancial statements. Only entries for the sanitation departmentare required here:

January 1—Received unrestricted funds of $160,000 from thegeneral fund as permanent financing.

February 1—Borrowed an additional $130,000 from a local bank ata 12 percent annual interest rate.

March 1—Ordered a truck at an expected cost of $108,000.

April 1—Received the truck and made full payment. The actualcost amounted to $110,000. The truck has a 10-year life and nosalvage value. Straight-line depreciation is to be used.

May 1—Received a $20,000 cash grant from the state to helpsupplement the pay of the sanitation workers. The money must beused for that purpose.

June 1—Rented a garage for the truck at a cost of $1,000 permonth and paid 12 months of rent in advance.

July 1—Charged citizens $13,000 for services. Of this amount,$11,000 has been collected.

August 1—Made a $10,000 cash payment on the 12 percent note ofFebruary 1. This payment covers both interest and principal.

September 1—Paid salaries of $18,000 using the grant received onMay 1.

October 1—Paid truck maintenance costs of $1,000.

November 1—Paid additional salaries of $10,000, first using therest of the grant money received May 1.

December 31—Sent invoices totaling $19,000 to customers forservices over the past six months. Collected $3,000 cashimmediately.

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