Question #80
Reading: Reading 8 Intercorporate Investments
PDF File: Reading 8 Intercorporate Investments.pdf
Page: 35
Status: Unattempted
Correct Answer: B
Question
Which of the following statements regarding asset securitizations and special purpose entities (SPEs) is most accurate?
Answer Choices:
A. When receivables are securitized, the sponsor reports the cash inflow as an investing activity in the cash flow statement
B. The SPE usually issues debt to purchase receivables from the sponsor
C. If the sponsor has no recourse, then the transaction is nothing more than a collateralized borrowing. Joseph Haggs, CFA, is an analyst working for Garvess Jones, a large publicly traded investment-banking firm. Haggs covers the internet sector. Recently, one of the more successful companies Haggs covers, Simpson Corporation, made an aggressive move to acquire another internet company, Bailey Corporation (BC). BC is a company specializing in graphics and animation on the World Wide Web and has 1,000,000 shares outstanding. Simpson also holds minimal investments in other technology companies both public and private. In 1999 Simpson saw an opportunity to substantially increase its share in BC. Simpson feels that their sophisticated animation can greatly improve Simpson's market
Explanation
SPEs are often created to securitize assets, usually receivables of the sponsor. Typically,
the SPE issues debt to purchase the receivables from the sponsor and the debt is repaid
as the receivables are collected.
When the receivables are securitized, the sponsor removes the receivables from the
balance sheet and reports the cash inflow as an operating activity in the cash flow
statement. If the sponsor still has recourse, the transaction is nothing more than a
collateralized borrowing.
(Module 8.9, LOS 8.a)
Joseph Haggs, CFA, is an analyst working for Garvess Jones, a large publicly traded
investment-banking firm. Haggs covers the internet sector. Recently, one of the more
successful companies Haggs covers, Simpson Corporation, made an aggressive move to
acquire another internet company, Bailey Corporation (BC). BC is a company specializing in
graphics and animation on the World Wide Web and has 1,000,000 shares outstanding.
Simpson also holds minimal investments in other technology companies both public and
private. In 1999 Simpson saw an opportunity to substantially increase its share in BC.
Simpson feels that their sophisticated animation can greatly improve Simpson's market
share and sees an acquisition as an opportunity to expand their business. The relevant
financial data are in the following tables.
Bailey Corporation
Selected Financial Data, Years Ended December 31
(in Thousands)
Item
1998
1999
2000
Sales
$50,000
$60,000
$70,000
Less: cost of goods sold
(COGS)
37,000
43,700
47,250
Earnings before interest &
taxes (EBIT)
13,000
16,300
22,750
Less: Interest
10,000
13,000
19,000
EBT
3,000
3,300
3,750
Less: Taxes
1,000
1,100
1,250
Net Income
$2,000
$2,200
$2,500
Dividends Paid
$1,000
$1,200
$1,500
Total Shares Outstanding
1,000,000
Simpson's Purchase Transactions in BC's Stock
Date
January 1, 1998
January 1, 1999
January 1, 2000
Number of Shares
10,000
290,000
700,000
Price per Share
10
11
15
Because this is the largest acquisition in Simpson's history, Mr. Haggs' supervisor has asked
him to prepare a report for Garvess Jones' clients detailing the effects of the acquisition on
Simpson's financial statements.