Relevant Ltd. operates under ideal conditions of uncertainty. Its operations are highly dependent on the weather. For any given year, the probabilities are 0.3 that the weather will be bad and 0.7 that it wLU be good. These state probabilities are independent over time. That is, the state probabilities for a given year are not affected by the actual weather in previous years.

Relevant Ltd. produces a single product for which the demand will fall to zero at the end of 2 years. It produces this product using specialized machinery, which will have no value at the end of 2 years. The machinery was purchased on 1 January, 2001. It was financed in part by means of a bank loan of $2,000 repayable at the end of 2002, with the balance financed by capital stock. No dividends will be paid until the end 2002. Interest on the bank loan is payable at the end of each year. The interest rate in the economy is 6%.

Cash flows are not received until the end of each year. Amounts of cash flows for each year are given in the following payoff table:

State realization for 2001 is good weather.

Required 

a. Prepare, in good form, a balance sheet for Relevant Ltd. as at the end of 2001 and an income statement for 2001.

b. As at January 1, 2002, how much is expected net income for 2002?

c. Explain why the financial statements you have prepared in part a are both completely relevant and completely reliable. Note: In the following two problems, state probabilities are not independent over time.

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CASH FLOW YEAR 1 CASH FLOW YEAR 2 STATE PROBABILITY Bad weather 0.3 $600 Good weather 0.7 $6000 $400 $3000