Ulon is a separate legal entity that provides leasing services. It was formed with an investment of $85 million, of which $76.4 million was financed by debt, and the remainder was provided by outside equity interests. Qualitative analysis is inconclusive in determining whether Ulon is a variable interest entity. Quantitative analysis indicates that Ulon's expected future cash flows are as follows, in millions (assume a one-year time frame, with cash flows occurring at the end of the year):
$$\begin{array} { | c | c | }
\hline \text { Expected Cash Flows } & \text { Probability } \
\hline \$ 115.00 & 0.60 \
\hline 80.50 & 0.30 \
\hline 46.00 & 0.10 \
\hline
\end{array}$$ A risk-adjusted discount rate of 15% is appropriate.
Is Ulon likely to be a variable interest entity, per U.S. GAAP?

Question

Ulon is a separate legal entity that provides leasing services. It was formed with an investment of $85 million, of which $76.4 million was financed by debt, and the remainder was provided by outside equity interests. Qualitative analysis is inconclusive in determining whether Ulon is a variable interest entity. Quantitative analysis indicates that Ulon's expected future cash flows are as follows, in millions (assume a one-year time frame, with cash flows occurring at the end of the year):
$$\begin{array} { | c | c | } 
\hline \text { Expected Cash Flows } & \text { Probability } \
\hline \$ 115.00 & 0.60 \
\hline 80.50 & 0.30 \
\hline 46.00 & 0.10 \
\hline
\end{array}$$ A risk-adjusted discount rate of 15% is appropriate.
Is Ulon likely to be a variable interest entity, per U.S. GAAP?

Quizplus · Accepted Answer

To determine if Ulon is likely a variable interest entity, we need to calculate the expected losses and compare them to the equity interest. The expected cash flows are given, so we calculate the expected value (EV) of these cash flows: EV = (115 * 0.60) + (80.5 * 0.30) + (46 * 0.10) = 69 + 24.15 + 4.6 = 97.75 million. The initial investment is $85 million, so the expected profit is $97.75 million - $85 million = $12.75 million. Since there are no expected losses (the calculation shows expected profit instead), the focus shifts to the equity investment's adequacy to absorb variability. However, the correct answer hinges on understanding the criteria for a variable interest entity, particularly regarding the sufficiency of equity investment to absorb losses, which is misinterpreted in the provided choices. The actual determination involves more nuanced criteria, including the entity's ability to finance its activities independently or the equity investors' rights and obligations. Given the information and the misalignment with U.S. GAAP criteria for variable interest entities, the explanation provided does not accurately reflect the correct approach to determining a variable interest entity status based on expected losses or equity investment sufficiency.

Ulon Is a Separate Legal Entity That Provides Leasing Services