Marham Roynold Ltd., a publicly traded company, owns and manages commercial and construction projects with a focus on environmentally friendly buildings. Marham Roynold needs advice on the proper way to value and account for investments on its December 31, 2011, financial statements.
Investment #1: A $3.5-million investment in the common shares of an oil company purchased early in the year. By December 31, the shares' fair value had risen to $4.2 million. Marham Roynold's senior management has noted that the recent, rapid increase in the market value of these shares is due to the rise in oil prices, but, given the international situation, they are not sure that the increase in value will be sustained. The managers are considering the sale of the investment to realize the gain, but they are concerned that if they sell now, an opportunity to earn further gains on this investment could be lost.
Investment #2: A $2.5-million investment in the bonds of an alternative energy company that were acquired five years ago, with a current fair market value of $1.5 million. Although the common shares of this alternative energy company have fallen in market value, the company remains solvent and the senior management of Marham Roynold are of the opinion that this is a good long-term investment. Marham Roynold will be facing a significant income tax liability next year when a major construction project comes to a profitable close. If it sold this investment, it would consider a similar purchase in the future.
Instructions
After the class has been divided into groups and you have been assigned one of the two investments for analysis, do the following:
(a) Identify the classification options (debt or equity; short-term or long-term) that are available for the investments described above. Discuss the appropriateness of each option and recommend the best classification.
(b) Based on your recommendation in (a), determine the valuation model that should be used for each investment at December 31, 2011.
(c) Assuming the two investments are sold in 2012, identify the impact of this sale on the financial statements