Assume that Wal-Mart sells the land on December 31, Year 6, for a note receivable with a present value of $180,000 instead of for cash. The note bears interest at 8 percent and requires cash payments of $100,939 on December 31, Year 7 and Year 8. Interest rates for notes of this risk level increase to 10 percent on December 31, Year 7, resulting in a market value for the note on this date of $91,762.
For Information: Refer to Problem 2.8.
Required
Ignore income taxes. Using the analytical framework discussed in the chapter, indicate the effect of the preceding information for Year 7 and Year 8 under each of the following valuation methods:
a. Valuation of the note at the present value of future cash flows using the historical market interest rate of 8 percent.
b. Valuation of the note at the present value of future cash flows using the current market interest rate of 8 percent for Year 7 and 10 percent for Year 8. Include unrealized holding gains and losses in net income.
c. Why is retained earnings on December 31, Year 8, equal to $101,878 in both cases despite the reporting of different amounts of net income each year?