Question

Pacific Energy Corp. (PEC) needs to build a power plant in order to meet the energy needs of its local customers. PEC is a publicly held company, and as such is concerned that the financing required to build a plant of its own would negatively impact its financial statements. Therefore, it partners with Sunshine Financial to create a special company called SoCal Electric which will build the new power plant, and then lease it to PEC. The energy from the plant will primarily be used to meet PEC's needs but will also be sold to power companies in Arizona and New Mexico. In the agreement, PEC purchases 90% of the SoCal Electric stock for $9,000,000 and Sunshine Financial purchases the other 10% for $1,000,000. Profits are to be split equally between Pacific Energy and Sunshine Financial. Sunshine Financial agrees to absorb the losses incurred during the first year (estimated to be $2,500,000) while the plant is being built and to guarantee the $120,000,000 in loans that SoCal Electric will need to finance the construction.

• Which company is the primary beneficiary, PEC or Sunshine Financial? Who has the Controlling Financial Interest? Explain Why.

Answer 1

The primary beneficiary in this case will be Sunshine Financial. It should be noted that primary beneficiary is that organization that is first in line to receive benefits. In this case Sunshine Financial has contributed both towards debt as well as equity of SoCal Electric while PEC has contributed only towards the equity. This makes Sunshine Financial the primary beneficiary.

The controlling financial interest vests with PEC. This is because PEC has purchased 90% of the SoCal Electric stock and so it has the direct ownership control of SoCal. Equity represents ownership of a company and here PEC holds more than 50% of SoCal’s equity.