In September 2013, Lyon Precision Corporation (LPC) decided to launch an expansion plan for some product lines. To finance this expansion, the firm has decided to issue $ 400,000,000 of new common stock in November 2013.
Historically, the firm’s innovative cell phone was a significant contributor to corporate profits. However, a competitor has recently introduced a multifunctional cell phone that has rendered LPC’s cell phone obsolete. The controller has informed LPC’s president that the inventory value of the cell phones needs to be reduced to its net realizable value. Because LPC has a large inventory of the cell phones in stock, the write- down will have a very detrimental effect on both the balance sheet and income statement.
The president, whose compensation is determined in part by corporate profits and in part by stock price, has suggested that the write- downs be deferred until January 2014. He argues that, by deferring the write-down, existing shareholders will realize more value from the shares to be sold in November because the stock market will not be informed of the pending write-downs.
a. What effects are the performance evaluation measures of the president likely to have on his decision to defer the write-down of the obsolete inventory?
b. Is the president’s decision to defer the write-down of the inventory and ethical treatment of existing shareholders? Of potential new shareholders?
c. If you were the controller of Lyon Precision Corporation, how would you respond to the president’s decision to defer the write-down until after issuance of the new stock?