Question #1

Reading: Reading 8 Intercorporate Investments

PDF File: Reading 8 Intercorporate Investments.pdf

Page: 2

Status: Incorrect

Correct Answer: A

Your Answer: C

Part of Context Group: Q1-4 First in Group
Shared Context
equipment in exchange for 100% of QuickTime's nonvoting stock. In addition, the outside investor is guaranteed an 8% annual return for the life of the financing term. At the end of seven years, QuickTime will be liquidated and Evergreen will have the option of purchasing the equipment for its fair value at that time. The proceeds of the liquidation will be used to repurchase the outside investor's stock at par value. In the event that the liquidation value is insufficient to buy back the outside investor's stock, Evergreen has committed to fund the shortfall. Management has given its tentative approval of the project and the proposed structure. Questions remain, however, as to the effect of the creation of QuickTime on Evergreen's financial statements. With the relatively recent issuance of FASB Interpretation No. 46(R), "Consolidation of Variable Interest Entities" (FIN 46(R)), the management of Evergreen has not had prior experience with the new consolidation requirements for SPEs.
Question
Which of the following statements regarding special purpose entities (SPEs) is least accurate?
Answer Choices:
A. An SPE can be established as one of several legal forms, such as corporations, partnerships, or trusts, but must establish separate management from that of the sponsor
B. In general, the equity investors in an SPE can expect to receive a limited rate of return on their investment in exchange for limited risk exposure
C. An SPE can be formed to isolate specific assets from the sponsor, thus lowering the cost of capital by protecting the assets of the SPE in the event the sponsor experiences financial distress
Explanation
An SPE can take on one of many legal forms, but does not necessarily have to have separate management or employees from that of the sponsor.
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