Domestic interest rates in Australia are below those of its trading partners - HSC - SSCE Business Studies - Question 19 - 2005 - Paper 1
Question 19
Domestic interest rates in Australia are below those of its trading partners. The Aussie Hat Company has borrowed funds to service the debt of an overseas subsidiary... show full transcript
Worked Solution & Example Answer:Domestic interest rates in Australia are below those of its trading partners - HSC - SSCE Business Studies - Question 19 - 2005 - Paper 1
Step 1
Increased gearing Improved solvency
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Answer
Increased gearing refers to a higher ratio of debt to equity in the company's capital structure. This means that the Aussie Hat Company is taking on more debt relative to its equity, which can lead to a higher financial risk. However, as the interest rates are lower in Australia, this may allow the company to service its debt more easily, potentially improving the solvency of the overseas subsidiary.
Step 2
Increased gearing Reduced solvency
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While increased gearing does enhance the risk profile of the relying company, it typically does not result in improved solvency. In fact, taking on more debt may lead to reduced solvency if the subsidiary struggles to generate sufficient income to cover its financial obligations.
Step 3
Reduced accounts payable Improved owner’s equity
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Reducing accounts payable means the company is clearing its short-term liabilities. While this can enhance liquidity, it does not inherently correlate to an improvement in owner’s equity in the context of the current strategy.
Step 4
Reduced accounts payable Reduced owner’s equity
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Reducing accounts payable has a neutral effect on owner’s equity. While it clarifies liability management, it does not necessarily decrease owner’s equity directly unless associated with losses or expenses.
