Consider ABC Ltd., one-asset firm with no liabilities. Assume that the asset will generate end-of-year cash flows each year for two years and then will have zero value. Assume also that the interest rate in the economy is 10%. The economy can be in a bad state or a good state during each year. In the good state (with 60% probability), end-of-year cash flows will be $300 for the year. In the bad state (with 40% probability), however, end-of-year cash flows will be $200 for the year. Our assumption that state probabilities are the same each year implies that the state realizations are independent. That is, the state realization in year 1 does not affect the probabilities of state realization in year 2. Also, assume dividend irrelevance and risk-neutral investors.

The year 1 state realization is a good economy. The year 2 state realization is a bad economy.

Required (show calculations for full credits) (a) Please use the traditional accounting methods to prepare ABCs balance sheet at the end of year 0, at the end year 1, and at the end of year 2, respectively, and ABCs income statement for year 1 and year 2, respectively. Note: under the traditional accounting methods, the income statement includes items such as revenue, amortization expense, and net income. Assume straight-line amortization. (15 marks) (b) Please use the information of ABC Ltd. to illustrate Feltham and Ohlson (1995) models prediction at the end of year 1, i.e., PAt = BVt + Gt, where PA is market value of equity, BV is accounting book value of equity, and G is goodwill or present value of future abnormal earnings, all measured at the end of year 1. Assume straight-line amortization. (10 marks)