Larry’s Lawn Equipment sells high-quality lawn mowers and offers a 3-year warranty on all new lawn mowers sold. In 2008, Larry sold $300,000 of new specialty mowers for golf greens for which Larry’s service department does not have the equipment to do the service. Larry has entered into an agreement with Mower Mavens to provide all warranty service on the special mowers sold in 2008. Larry wishes to measure the fair value of the agreement to determine the warranty liability for sales made in 2008. The controller for Larry’s Lawn Equipment estimates the following expected warranty cash outflows associated with the mowers sold in 2008.

Instructions

Using expected cash flow and present value techniques, determine the value of the warranty liability for the 2008 sales. Use an annual discount rate of 5%. Assume all cash flows occur at the end of the year.

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Cash Flow Probability Year Estimate Assessment $2,000 4,000 2009 20% 60% 5,000 20% $2,500 5,000 2010 30% 50% 6,000 20% 2011 $3,000 30% 6,000 40% 7,000 30%