Craig Brokaw, newly appointed controller of STL, is considering ways to reduce his company’s expenditures on annual pension costs. One way to do this is to switch STL’s pension fund assets from First Security to NET Life. STL is a very well-respected computer manufacturer that recently has experienced a sharp decline in its financial performance for the first time in its 25-year history. Despite financial problems, STL still is committed to providing its employees with good pension and postretirement health benefits.
Under its present plan with First Security, STL is obligated to pay $43 million to meet the expected value of future pension benefits that are payable to employees as an annuity upon their retirement from the company. On the other hand, NET Life requires STL to pay only $35 million for identical future pension benefits. First Security is one of the oldest and most reputable insurance companies in North America. NET Life has a much weaker reputation in the insurance industry. In pondering the significant difference in annual pension costs, Brokaw asks himself, “Is this too good to be true?”
Answer the following questions.
(a) Why might NET Life’s pension cost requirement be $8 million less than First Security’s requirement for the same future value?
(b) What ethical issues should Craig Brokaw consider before switching STL’s pension fund assets?
(c) Who are the stakeholders that could be affected by Brokaw’s decision?
The requirement will be less due to various actuaries' assumptions. Craig may face an ethical dilemma, and the stakeholders are the company and retirees.
It totally depends on the time value of money for N life. The cost of the capital of N Life is much lesser than F security. The premiums which are paid depend on various assumptions such as life expectance, employee turnover, salary, wage, etc. The N life actuaries' assumptions are different as compared to F security. As a result, the pension cost requirement of N life is less than F security for the same future value.
Craig is the controller of pension funds and is in a trustworthy and responsible position towards the retirees of the business. He has the responsibility of ensuring that adequate funds of pension assets are present. Craig is also responsible for enhancing the company's financial condition and acting ethically. This role of Craig will sometimes lead to ethical conflict.
The company and retirees are the stakeholders who are affected by the decision of Craig.
Killroy Company owns a trade name that was purchased in an acquisition of McClellan Company. The trade name has a book value of $3,500,000, but according to GAAP, it is assessed for impairment on an annual basis. To perform this impairment test, Killroy must estimate the fair value of the trade name. (You will learn more about intangible asset impairments in Chapter 12.) It has developed the following cash flow estimates related to the trade name based on internal information. Each cash flow estimate reflects Killroy’s estimate of annual cash flows over the next 8 years. The trade name is assumed to have no salvage value after the 8 years. (Assume the cash flows occur at the end of each year.) Probability Cash Flow Estimate Assessment $380,000 20% 630,000 50% 750,000 30% Instructions (a) What is the estimated fair value of the trade name? Killroy determines that the appropriate discount rate for this estimation is 8%. (b) Is the estimate developed for part (a) a Level 1 or Level 3 fair value estimate? Explain.
Keith Bowie is trying to determine the amount to set aside so that he will have enough money on hand in 2 years to overhaul the engine on his vintage used car. While there is some uncertainty about the cost of engine overhauls in 2 years, by conducting some research online, Keith has developed the following estimates. Engine Overhaul Probability Estimated Cash Outflow Assessment $200 10% 450 30% 600 50% 750 10%
Instructions How much should Keith Bowie deposit today in an account earning 6%, compounded annually, so that he will have enough money on hand in 2 years to pay for the overhaul?
Answer the following questions related to Dubois Inc.
(a) Dubois Inc. has $600,000 to invest. The company is trying to decide between two alternative uses of the funds. One alternative provides $80,000 at the end of each year for 12 years, and the other is to receive a single lump-sum payment of $1,900,000 at the end of the 12 years. Which alternative should Dubois select? Assume the interest rate is constant over the entire investment.
(b) Dubois Inc. has completed the purchase of new Dell computers. The fair value of the equipment is $824,150. The purchase agreement specifies an immediate down payment of $200,000 and semiannual payments of $76,952 beginning at the end of 6 months for 5 years. What is the interest rate, to the nearest percent, used in discounting this purchase transaction?
(c) Dubois Inc. loans money to John Kruk Corporation in the amount of $800,000. Dubois accepts an 8% note due in 7 years with interest payable semiannually. After 2 years (and receipt of interest for 2 years), Dubois needs money and therefore sells the note to Chicago National Bank, which demands interest on the note of 10% compounded semiannually. What is the amount Dubois will receive on the sale of the note?
(d) Dubois Inc. wishes to accumulate $1,300,000 by December 31, 2027, to retire bonds outstanding. The company deposits $200,000 on December 31, 2017, which will earn interest at 10% compounded quarterly, to help in the retirement of this debt. In addition, the company wants to know how much should be deposited at the end of each quarter for 10 years to ensure that $1,300,000 is available at the end of 2027. (The quarterly deposits will also earn at a rate of 10%, compounded quarterly.) (Round to even dollars.)
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