Rainy Ltd. operates under ideal conditions of uncertainty. Its cash flows dependcrucially on the weather. On January 1, 2010, Rainy acquired equipment to beused in its operations. The equipment will last two years, at which time itssalvage value will be zero. Rainy financed the equipment purchase by issuingcommon shares.
In 2010, net cash flows will be $700 if the weather is rainy and $200 if it is dry.In 2011, cash flows will be $900 if the weather is rainy and $300 if it is dry. Cashflows are received at year-end. In each year, the probability that the weather israiny is 0.3 and 0.7 that it is dry. The interest rate in the economy is 6% in bothyears.
Rainy pays a dividend of $50 at the end of 2010.
Required
a. In 2010, the weather is rainy. Prepare a balance sheet as at the end of2010 and an income statement for 2010.
b. If we attempt to apply the present value model under uncertainty to themore realistic conditions under which accountants operate, the expectedpresent value calculations often become unreliable. Explain why.
c. Explain why well-defined (i.e., “true”) net income does not exist under therealistic conditions under which accountants operate. In place of true net