Understanding The Issues

1. Subsidiary Company S has $1,000,000 of bonds outstanding. The bonds have 10 years to maturity and pay interest at 12% annually. The parent has an average annual borrowing cost of 9% and wishes to reduce the interest cost of the consolidated company. What methods could be used to maintain the subsidiary as the debtor?

2. Subsidiary Company S has $1,000,000 of bonds outstanding at 12% annual interest. The bonds have 10 years to maturity. If the parent, Company P, is able to purchase the bonds at a price that reflects 10% annual interest, what effect will the purchase have on income in the current and future years? What would the effects be if the purchase price reflected a 13% annual interest rate? Your response need not be quantified.

3. Subsidiary Company S has $1,000,000 of bonds outstanding at 12% annual interest. The bonds have 10 years to maturity. If the parent, Company P, is able to purchase the bonds at a price that reflects 10% annual interest, how will the noncontrolling interest be affected in the current and future years? Your response need not be quantified.

4. Company P purchased $100,000 of subsidiary Company S's bonds for $95,000 on January 1, 20X1. The bonds were issued at face value, pay interest at 10% annually, and have 5 years to maturity. What will the impact of this transaction be on consolidated net income for the current and future 4 years? Assuming a 20% noncontrolling interest, how will the NCI be affected in the current and next 4 years? Quantify your response.

5. Your friend is a noncontrolling interest shareholder in a large company. He knows that the subsidiary company leases most of its assets from the parent company under operating leases. He further believes that the lease rates are in excess of market rates. He made his concern known to the parent company management. Their response was, "Don't worry about it; it washes out in the consolidation process and ends up having no effect on income." Your friend wants to know if this is true and if he was wrong to be concerned.

6. A parent company may want to shift profits to the controlling interest and may use intercompany capital leases to accomplish that end. Is there an opportunity to do that with both direct financing and sales-type leases? What are the differences between the two types of leases with respect to income shifting?

7. A parent company is a producer of production equipment, some of which is acquired and used by the parent's subsidiary companies. The parent offers a discount to the subsidiaries but still earns a significant profit on the sales of equipment to a subsidiary. Is there any difference in the consolidated company's ability to recognize the profit on these sales if, instead of selling equipment to the subsidiaries, the equipment is leased to them under capital leases? Are there any other profit opportunities for the controlling interest in leasing as opposed to selling equipment to the subsidiaries?

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