Schweser Vol2 2PM #84 - Divestiture

EPI entered into a joint venture and uses the equity method under GAAP. A year later, EPI decides to sell its interest in this joint venture. Which statement is least likely regarding the sale? The divestiture: a. may be signaling a poor operating choice and prior bad acquisitions. b. could be used to manage earnings by lowering the company’s overall debt level. c. is sending a positive signal that management is able to sell assets at a good price. answer C Why isn’t it B? Since EPI used the equity method, there shouldn’t be any debt from the joint venture in EPI’s balance sheet, therefore selling it wouldn’t decrease EPI’s overall debt level.

The company most likely borrowed to purchase the stake in the joint venture. If they sell the asset, the proceeds could be used to pay down some of the debt… at least that is my reasoning.

Not all aquisitions are cash, most use debt. So, it would be reasonable to assume that a divestiture would lower overall leverage, and possibly increase earnings (lower interest expense and by getting rid of an unprofitable business)