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?

Donahoe Company has a liability of $10,000, which is due in three years. The discount rate applicable to the liability 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 liability 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.