Chapter 1, Problem 1.1B.2C

Frontier does not have publicly traded stock. You make an estimate of the value of the company based on the following assumptions that will later be included in the reporting unit valuation procedure:

a. Frontier will provide operating cash flows, net of tax, of $150,000 during the next fiscal year.

b. Operating cash flows will increase at the rate of 10% per year for the next four fiscal years and then will remain steady for 15 more years.

c. Cash flows, defined as net of cash from operations less capital expenditures, will be discounted at an after-tax discount rate of 12%. An annual rate of 12% is a reasonable risk-adjusted rate of return for investments of this type.

d. Added capital expenditures will be $100,000 in year 5 $120,000 in year 10, and $130,000 in year 15.

e. An estimate of salvage value (net of the tax effect of gains or losses) of the assets after 20 years is estimated to be $300,000. This is a conservative assumption since the unit may be operated after that period.

2. Compare the estimated fair value of the reporting unit with amounts assigned to identifiable assets plus goodwill less liabilities.