Model Engineering is a large corporation with the ability to obtain financing by selling its bonds at favorable rates. Currently, it pays 5% interest on its 10-year bond issues. In the past year, Model acquired an 80% interest in Mercer Industries. Mercer Industries has $1,000,000 of bonds outstanding that mature in six years. Interest is paid annually at a stated rate of 8%. The bonds were issued at face value.
Interest rates have come down, but Mercer Industries can still expect to pay 5% to 6.5% interest on a long-term issue. Mercer Industries is a smaller company with a lower credit rating than Model.
Model would like to reduce interest costs on the Mercer Industries debt. The company has asked your advice on whether it should purchase the bonds or loan Mercer Industries the money to retire its own debt. Compare the options with a focus on the impact on consolidated statements.