Question
BACKGROUND: Assume now that Frankies has finished construction of the new cheese superstore along Route 5 and capitalized $1.9 million related to the project as
BACKGROUND:
Assume now that Frankies has finished construction of the new cheese superstore along Route 5 and capitalized $1.9 million related to the project as of the stores opening on 1/1/20X1. As of 12/31/X1, the current carrying value of the shop is $1.805 million (assuming a 20-year life for the store and straight-line depreciation). As of 12/31/X1, Frankies notices that a few negative factors are at play and asks you whether it is required to test the superstore for impairment: 1. A key stock market index (the Dow) has slid 1,500 points, or 6%, since the store was opened. 2. Monthly sales have slid by 10% since the store was opened, partially due to a construction project on Route 5 that has reduced traffic flow to the area. 3. As a result of the slide in monthly sales, the store operated at a deficit in October, November, and December of 20X1. Assume the fair value of the store at 12/31/X1 is $1.7 million. As of 12/31/X1, Frankies estimates the store will produce net cash inflows of $50,000 in year 2, $100,000 each in years 35, $150,000 each in years 610, $175,000 each in years 1115, and $200,000 each in years 1620. Note that Frankies incremental borrowing rate is 6%.Is the store required to be tested for impairment? Should Frankies impair the current carrying value of the store at 12/31/X1?
ANSWER:
As per IFRS an impairment losses is recognized when carrying value of asset is greater than recoverable amount.
The recoverable amount is greater of :
- Fair value less cost to sell
- Present value of future cash flow
The carrying value of asset provided is $1.805 B
Fair value of asset provided is $1.7 Billion
Present value of future cash flow works out to $1.6M
Since Fair value is greater than present value of future cash flow, $1.7B will be considered as recoverable amount.
Since carrying amoount of $1.805B is lesser than $1.7 Billion, Impairement loss of $0.105B needs to be recognised
Working note for future cash flow :
Year | Cash Flow |
2 | 50,000.00 |
3 | 100,000.00 |
4 | 100,000.00 |
5 | 100,000.00 |
6 | 150,000.00 |
7 | 150,000.00 |
8 | 150,000.00 |
9 | 150,000.00 |
10 | 150,000.00 |
11 | 175,000.00 |
12 | 175,000.00 |
13 | 175,000.00 |
14 | 175,000.00 |
15 | 175,000.00 |
16 | 200,000.00 |
17 | 200,000.00 |
18 | 200,000.00 |
19 | 200,000.00 |
20 | 200,000.00 |
NPV | $1,608,781.30 |
MY QUESTION:
How is the NPV $1,608,781.30?
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