Question

Question 6:

Olivia Hardison, CFO of Impact United Athletic Designs, plans to have the company issue $500 million of new common stock and use the proceeds to pay off some of its outstanding bonds. Assume that the company, which does not pay any dividends, takes this action, and that total assets, operating income (EBIT), and its tax rate all remain constant. What affect it can have on the company’s financial statements. Discuss.

Answer 1

Simply put, the company's debt-equity ratio will decline.

• Debt will decrease by $500 million, and Equity will increase by $500 million.
• It is worthy to note that the Interest payments to be claimed as expenses will also decline due to decrease in debt - this leads to a higher earnings available to common stockholders.
• Extrapolating from that: Interest payment being declined indicates availability of more cash (or bank) balance because they would not have to pay interest.
• However, there will not be tax savings on account of interest charges.
  
  So,
  - Equity increases
  - Debt decreases
  - Retained Earnings increases
  - Cash increases
  - Tax payments increases - which will decrease cash by an amount lesser than how much it would increase due to not paying interest.

I believe entire scenario is analysed. Normally we could say that Total Dividends will also increase, but it is not applicable here as the question clearly says it "does not pay any dividends".

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