Advanced Accounting 11th Edition by Paul Fischer,William Tayler, Rita Cheng

Exercise 31

Options to lower interest cost. Mode Engineering is a large corporation with the ability to obtain financing by selling its bonds at favorable rates. Currently, it pays 6% interest on its 10-year bond issues. In the past year, Mode acquired an 80% interest in Metel Industries. Metel Industries has $1,000,000 of bonds outstanding that mature in six years. Interest is paid annually at a stated rate of 9%. The bonds were issued at face value.
Interest rates have come down, but Metel Industries can still expect to pay 7% to 8.5% interest on a long-term issue. Metel Industries is a smaller company with a lower credit rating than Mode.
Mode would like to reduce interest costs on the Metel Industries debt. The company has asked your advice on whether it should purchase the bonds or loan Metel Industries the money to retire its own debt. Compare the options with a focus on the impact on consolidated statements.