Purpose: This exercise will apply the expected cash flow approach.
Ozzie Electronics sells high-end plasma TVs and offers a 3-year warranty on all new TVs sold. Ozzie has entered into an agreement with Electronic Service Labs to provide all warranty services on the 95 TVs sold in 2013. The controller for Ozzie estimates the following expected warranty cash outflow associated with the TVs sold in 2013.
|
Cash Flow Estimate
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Probability Assessment
|
|
2014
|
$20,000
|
20%
|
|
30,000
|
60%
|
|
40,000
|
20%
|
|
2015
|
$25,000
|
30%
|
|
30,000
|
50%
|
|
45,000
|
20%
|
|
2016
|
$30,000
|
20%
|
|
45,000
|
40%
|
|
|
60,000
|
40%
|
Instructions
Determine the fair value of the warranty liability for the sales made in 2013. Use expected cash flow and present value techniques. Use an annual discount rate of 6%.