economic valuation and disaggregation23 Ralph's firm operates in a world of complete and perfect markets. The prevailing interest rate is 10%. Ralph's firm pays out eaeh year's eash flow in dividends.

a] Suppose Ralph's firm consists of a single depreciable asset with a 5 year life.

The asset produees end-of-year net eash flows as follows:

23Contributed by Rick Antle.

year netCF 1 270 2 195 3 185 4 175 chapter 3 5 95 Construet economie balanee sheets as of the beginning and endofyear 1. Construet an economie ineome statement for year 1.

b] Now suppose Ralph' s firm consists of not one, but nine different eomponents.

The components sum to the same net eash flows forthe firm as in part [a]. The eash flows from the nine components are:

year 1 2 3 4 5 components:

1 200 200 200 200 200 2 50 40 30 20 10 3 40 4 80 5 -35 6 0 -60 -60 -60 -60 7 -300 8 20 20 20 20 220 9 -5 -5 -5 -5 -55 total net CF 270 195 185 175 95 Notiee we have already separated items with positive eash flows from those with negative flows. This corresponds to an aecountant's distinetion of assets and liabilities. Prepare economie balanee sheets as of the beginning and end of year 1 and the end of year 2. Try your hand at elassifying items the way an aecountant would: current versus long-term assets, eurrent versus long-term liabilities, and equities. Also prepare economie income statements for years 1 and 2 with your elassifieation. As aguideline, accounting conventions would eall an inerease in the value of an asset a holding gain and a deerease in value depreciation.

e] As you do the problem, think about what assets or liabilities found in praetice might have cash flow pattems similar to the 9 eomponents of Ralph's firm. Also, think about accounting conventions of classifieation and aggregation in relation to economic value and eeonomic income. Would anyone in the perfect markets setting eare about the income statements and balanee sheets produeed in part [b]; or would they just eare about the net pietured in part [a]? How would your answer ehange if the setting were aetual praetiee instead of the textbook setting of perfect markets?

AppendixLO1