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President and Chairman of Sky Company plan to have the company issue $700 million of new...

President and Chairman of Sky Company plan to have the company issue $700 million of new equity and use the proceeds to pay off some of its outstanding debts. Assume that the company, which does not pay any dividends, takes this action, and that total assets, operating income, and its tax rate all remain constant. What impact could this decision have on the financial statements of the company? Explain with reasoning

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Expert Solution

Impact on the Income Statement:

  • Interest expenses will reduce as there will be lower interest due to lower debt
  • Taxable income (Earnings before taxes) will be higher
  • Taxes will be higher (Interest is lower and hence interest tax shields will be lower)
  • Net income will be higher
  • Since company doesn't pay any dividends, retained earnings will be higher

Impact on the Balance Sheet

  • Total value under equity of the company will increase
    • First due to issuance of new shares (this will increase the value under paid up capital and additional paid up capital)
    • Secondly due to increase in retained earnings
  • Total value under debt (bonds) of the company will decrease.

Impact on the cash flow statement:

  • Interest expenses will be lower
  • Taxes will be higher

jeff jeffy answered 2 years ago
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