Part 1. Tucker Company has an asset in the form of a cash flow that it expects to

collect in three years. However, the amount of the cash flow is not certain. These are

the probabilities underlying the cash flow.

Amount Probability

$3,000 .30

$4,000 .30

$5,200 .40

The discount rate is 10%.

Required:

a. How should the asset be valued according to SFAC No. 7?

b. What other valuation is possible?

c. Which valuation do you prefer?

Part 2. Donahoe Company has a liability of $10,000 which is due in three years. The

discount rate applicable to the firm is 10%. Assume that the firm's credit standing is

adversely affected by an untoward economic event. As a result, the discount rate

applicable to the firm goes up to 12%.

Required:

a. How does the value of the liability change?

b. If the firm's financial condition worsens, does it make sense for the value of the

liabilities to decline? Explain.