Question #79

If Flitenight accounted for its Rocky Mountain investment using the equity method, the value of the investment as of December 31, 2004, would be: Flitenight's original $10 million investment + (Flitenight's share of Rocky Mountain's 2003 earnings less dividends Flitenight received in 2003) + (Flitenight's share of Rocky Mountain's 2004 earnings less dividends Flitenight received in 2004). Since we know that Flitenight owns 20% of Rocky Mountain and consequently receives 20% of the dividends that Rocky Mountain pays, we can calculate: Value of Rocky Mountain on Flitenight's books at the end of 2004 = $10 million + (0.20 × $3 million in 2003 earnings − 0.20 × $1.5 million in 2003 dividends) + (0.20 × −$800,000 in 2004 earnings − 0.20 × $1 million in 2004 dividends) = $10 million + ($600,000 − $300,000) + (−$160,000 − $200,000) = $10,000,000 + $300,000 − $360,000 = $9,940,000 Basten's statement is correct. On a cash basis, Flitenight spent $10 million to acquire its stake in Rocky Mountain, and received $500,000 (= $300,000 in 2003 dividends + $200,000 in 2004 dividends) in dividends over the two years. $500,000 in cash return on a $10,000,000 cash investment equals 5% over the two years. Matthews' statement is also correct.