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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
Answer
This option suggests that the Australian Hat Company's increase in gearing would lead to better solvency for the overseas subsidiary. However, increasing gearing implies taking on more debt, which typically elevates financial risk and does not necessarily result in improved solvency. Therefore, this combination is incorrect.
Step 2
Increased gearing: Reduced solvency
Answer
In this case, the increase in gearing for the Aussie Hat Company would likely be detrimental to the solvency of the overseas subsidiary. High levels of debt can strain a company's financial situation, leading to reduced solvency. Thus, this statement is plausible.
Step 3
Reduced accounts payable: Improved owner's equity
Answer
Reducing accounts payable means the company is paying off its short-term debts. This action could improve owner’s equity; however, it does not relate directly to the impact of borrowing funds to service overseas debt. As such, while it may improve owner's equity, it does not accurately reflect the financial strategy's impact.
Step 4
Reduced accounts payable: Reduced owner's equity
Answer
This suggests that reducing accounts payable would somehow decrease owner's equity, which is counterintuitive. Paying off debts should improve the financial position rather than reduce owner’s equity. Therefore, this option does not accurately reflect the financial strategy's repercussions.