Reference no: EM132943354

Therma Inc. is a recently established 'green' company that is dedicated to the design and manufacture of innovative technologies that provide renewable energy solutions for homeowners and businesses while creating sustainable, well-paying jobs. Their grid-connected solar electric systems enable individuals to decrease their dependence on nuclear and fossil fuels, reduce greenhouse gas emissions, and embark on the road to a more secure energy future.

Therma has initiated a commercial 'biowall' project, which is considered a widely acceptable purchase by high-rise buildings and skyscrapers. The initial investment required for the project has been apportioned between debt and equity in the same ratio as the company's current capital structure mix. The project is expected to provide a return of $1.5 million in residual income for the next twenty five years, starting one year after the initial investment. The discount rate applicable to these cash flows has been calculated as 12%.

Provides summarized current financial information of Therma Inc.

Fair Value of Net Assets $12,000,000

Current Book Value of Net Assets $16,000,000

Number of Shares Outstanding 500,000

The financial analysts currently employed at Therma recently held a meeting to evaluate the feasibility of the biowall project. During a presentation of the financial feasibility of the project, Emma Thompson, a senior financial advisor, explained the prudence of using the residual income approach to value the project. In her explanation, she emphasized on how the approach is applicable in a situation where clean surplus accounting exists. Through communicating her confidence in the transparency of Therma's accounts, she was able to convince a majority of the analysts to vote in favor of the residual income approach.

Problem 1: The share value of Therma based on the residual income method is closest to:

A. $55.50/share
B. $23.50/share
C. $47.50/share

Problem 2: Which of the following options provides the most relevant explanation of the concept of clean surplus accounting?

A. The book value of the current year should equal the book value of the preceding year inclusive of the current year's earnings and exclusive of the year's common equity disbursements.
B. The value of a stock should portray the present value of expected future cash flows.
C. All financial statement transactions need to be reliable and transparent in nature.