Xeron Company forms a separate legal entity, Yolar, to develop new product technology. The entity is financed by $260 million, of which $235 million is debt financing, and the remainder is equity funding obtained from outside investors. Xeron guarantees Yolar's debt, and is heavily involved with Yolar's business activities. Yolar is expected to operate for one year and generate the following cash flows at the end of the year (in millions):
$$\begin{array} { | c | c | }
\hline \text { Expected Cash Flows } & \text { Probability } \
\hline \$ 448 & 0.10 \
\hline 336 & 0.50 \
\hline 224 & 0.30 \
\hline 112 & 0.10 \
\hline
\end{array}$$ A risk-adjusted discount rate of 12% is appropriate.
Required a. Qualitative is not conclusive regarding whether or not Yolar is a variable interest entity. Based on quantitative analysis, is Yolar a variable interest entity, per U.S. GAAP? Show calculations to justify your answer.
b. Who should consolidate Yolar? Explain how this decision is made.
c. Now assume Xeron follows IFRS. Should Xeron consolidate Yolar? Justify your answer.

Question

Xeron Company forms a separate legal entity, Yolar, to develop new product technology. The entity is financed by $260 million, of which $235 million is debt financing, and the remainder is equity funding obtained from outside investors. Xeron guarantees Yolar's debt, and is heavily involved with Yolar's business activities. Yolar is expected to operate for one year and generate the following cash flows at the end of the year (in millions):
 $$\begin{array} { | c | c | } 
\hline \text { Expected Cash Flows } & \text { Probability } \
\hline \$ 448 & 0.10 \
\hline 336 & 0.50 \
\hline 224 & 0.30 \
\hline 112 & 0.10 \
\hline
\end{array}$$ A risk-adjusted discount rate of 12% is appropriate.
Required a. Qualitative is not conclusive regarding whether or not Yolar is a variable interest entity. Based on quantitative analysis, is Yolar a variable interest entity, per U.S. GAAP? Show calculations to justify your answer.
b. Who should consolidate Yolar? Explain how this decision is made.
c. Now assume Xeron follows IFRS. Should Xeron consolidate Yolar? Justify your answer.

Quizplus · Accepted Answer

The Answer of Xeron Company forms a separate legal entity, Yolar, to develop new product technology. The entity is financed by $260 million, of which $235 million is debt financing, and the remainder is equity funding obtained from outside investors. Xeron guarantees Yolar's debt, and is heavily involved with Yolar's business activities. Yolar is expected to operate for one year and generate the following cash flows at the end of the year (in millions):
 $$\begin{array} { | c | c | } 
\hline \text { Expected Cash Flows } & \text { Probability } \
\hline \$ 448 & 0.10 \
\hline 336 & 0.50 \
\hline 224 & 0.30 \
\hline 112 & 0.10 \
\hline
\end{array}$$ A risk-adjusted discount rate of 12% is appropriate.
Required a. Qualitative is not conclusive regarding whether or not Yolar is a variable interest entity. Based on quantitative analysis, is Yolar a variable interest entity, per U.S. GAAP? Show calculations to justify your answer.
b. Who should consolidate Yolar? Explain how this decision is made.
c. Now assume Xeron follows IFRS. Should Xeron consolidate Yolar? Justify your answer.

Xeron Company Forms a Separate Legal Entity, Yolar, to Develop