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In: Accounting

When a parent company looks to purchase a subsidiary, there are many ways to fund the...

When a parent company looks to purchase a subsidiary, there are many ways to fund the purchase. The two most popular ways to pay for the new acquisition are: (1) To give the subsidiary cash for its acquisition, and (2) To give the subsidiary ownership percentage within the parent. Based on these facts, answer the following questions:

  • Under which circumstance would you use each of these methods?
  • Under what set of circumstances is each method most beneficial to the subsidiary?
  • Under what set of circumstances is each method most beneficial to the parent?
  • Which method costs the parent more?

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Expert Solution

This is a question that can have differing opinions and differing views. As mentioned in the question, there are 2 main ways in which subsidiaries are acquired. Either by paying cash to the subsidiary or by giving them shares in the parent company.

Now when would this be beneficial to parent and subsidiary depends on different scenarios.

There could be varying reasons why the subsidiary is selling itself to the parent. If the cause of concern is the need for immediate funds or something of that sort, then they would definitely go for the cash option because thats the whole purpose of the sale. So in this situation the subsidiary would be happy if they received cash in return of their company.

Now, in case the subsidiary is selling itself to the parent because they find it too hard to compete against the parent company and hence feel its better to be a part of them, then they would be happier to receive a share holding in the parent company in return for their company.

Similar is the situation for the parent company as well. It might not always be possible to lure a smaller firm to sell themselves. But if you feel its necessary for the well being of your company, they would go for the option of giving the subsidiary companies owners a share in their company.

Now in case the subsidiary is fairly small but have a good base and if they know the subsidiary can be easily purchased, they would go for the cash option as they wont wove to share future profits with them.

So in different situations , parent and subsidiary would be interested in different methods of sale.

Hope this answers your question. If you liked the answer please give an up-vote. It would be highly encouraging for me. Thank You.

ekkarill92 answered 2 years ago
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