Which of the following statements is correct ? A subsidiary’s financial structur

Question

Which of the following statements is correct?

A subsidiary’s financial structure is of little importance to the parent firm if the parent is not responsible for the financial obligations of the subsidiary.

A subsidiary’s financial structure is of little importance to the parent firm whether the parent is responsible or not for the financial obligations of the subsidiary.

An investment undertaken by a subsidiary should always be financed with the debt/equity proportion of the parent firm.

If the foreign corporate income tax is higher than the domestic one, a foreign investment should always be financed with as much foreign debt as possible.

A subsidiary’s financial structure is of little importance to the parent firm if the parent is not responsible for the financial obligations of the subsidiary.

A subsidiary’s financial structure is of little importance to the parent firm whether the parent is responsible or not for the financial obligations of the subsidiary.

An investment undertaken by a subsidiary should always be financed with the debt/equity proportion of the parent firm.

If the foreign corporate income tax is higher than the domestic one, a foreign investment should always be financed with as much foreign debt as possible.

Explanation / Answer

A subsidiary is a company in which the parent company or the holding company has a controlling interest i.e in which the parent company or the holding company holds more than 50% of voting stock.

Now, the parent company has a responsibility (it can be legal or a moral responsibility) for the subsidiary's financial obligations. Parent company will decide the financial structure of the subsidiary as it will affect the parent company's overall financial structure.

The subsidiary is, however, allowed to take advantage of favorable financing opportunities. The subsidiary compnay should take advantage of tax deductions of interest payments on debt taken by it. This can be done by increasing its borrowings when the corporate tax is higher in the host country than in the home country.

So, the answer is "If the foreign corporate income tax is higher than the domestic one, a foreign investment should always be financed with as much foreign debt as possible".

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