Over its life, a firm "earns what it earns." That is, its total cash flows and reported net incomes will be equal, regardless of the accounting policies used to report net income year-by-year.

Refer to Example 2.1, where RV. Ltd. has purchased a capital asset for $173.55.

Assume, contrary to the example, that RV. does not operate under ideal conditions. Assume flirter that its cash sales for each year are $100, as in the example, but that it uses straight hne amortization for the capital asset.
Required

a. Verify that over its 2-year life P.V.'s total czsh flows, historical cost accounting-
based earnings, and present value-based earnings are equal.

b. On realizing this equality, an investor suggests that P.V. drop annual reporting of net income and simply report annual cash flows. This, he says, will avoid the problems of matching costs and revenues, and will be just as useful since "it all comes out the same in the end." Do you agree with this suggestion?
Explain why or why not.

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EXAMPLE 2.1 THEORETICAL ILLUSTRATION OF THE PRESENT VALUE MODEL UNDER CERTAINTY Consider P.V. Ltd., a one-asset firm with no liabilities. Assume that the asset will generate end-of-year cash flows of $100 each year for two years and then will have zero value. Assume also that the risk-free interest rate in the economy is 10%. Then, at time 0 (the beginning of the first year of the asset's life), the present value of the firm's future cash flows, denoted by PA, is: PA $100 1.10 + $100 + (1.10) = $90.91 + $82.64 = $173.55 We can then prepare a present value opening balance sheet as follows: P.V. LTD. BALANCE SHEET As at Time 0 Capital asset, at present value $173.55 Shareholders' equity $173.55