In: Accounting
Clayton Industries has the following account balances:
Current assets | $ | 24,000 | Current liabilities | $ | 11,000 | ||
Noncurrent assets | 74,000 | Noncurrent liabilities | 60,000 | ||||
Stockholders’ equity | 27,000 | ||||||
The company wishes to raise $44,000 in cash and is considering two financing options: Clayton can sell $44,000 of bonds payable, or it can issue additional common stock for $44,000. To help in the decision process, Clayton’s management wants to determine the effects of each alternative on its current ratio and debt-to-assets ratio.
Required
a-1. Compute the current ratio for Clayton’s
management. (Round your answers to 2 decimal
places.)
Currently. to 1
If bonds are issued to 1
If stock is issued to 1a-2. Compute the debt-to-assets ratio for Clayton’s management. (Round your answers to 1 decimal place.)
Currently %
If bonds are issued %I
if stock is issued %
b. Assume that after the funds are invested, EBIT amounts to $15,700. Also assume the company pays $4,100 in dividends or $4,100 in interest depending on which source of financing is used. Based on a 40 percent tax rate, determine the amount of the increase in retained earnings that would result under each financing option.
Bonds
Stock
a-1. Current Ratio :-
Current Ratio = Current Assets / Current Liabilities
Currently Current Ratio = $24000/$11000 = 2.18 times
If Bonds are Issued = ($24000+$44000)/$11000 = $68000/$11000 = 6.18 times
If Stock are Issued = ($24000+$44000)/$11000 = $68000/$11000 = 6.18 times
a-2. Debt to Assets Ratio :-
Debt to Assets Ratio = (Current Liabilities + Non-current Liabilities) / (Current Assets + Non-current Assets)
Currently Debt to Assets Ratio = ($11000+$60000) / ($24000+$74000)
= $71000 / $98000
= 0.72 times
If Bonds are Issued = ($11000+$60000+$44000) / ($24000+$74000+$44000)
= $115000 / $142000
= 0.81 times
If Stock are Issued = ($11000+$60000) / ($24000+$74000+$44000)
= $71000 / $142000
= 0.50 times
2)
Particulars | Bonds Issued | Stock Issued |
EBIT | $15700 | $15700 |
Less : Interest on Bonds | ($4100) | - |
EBT | $11600 | $15700 |
Less : Tax @ 40% | $4640 | $6280 |
EAT | $6960 | $9420 |
Less : Dividend on Stock | - | $4100 |
Net Income | $6960 | $5320 |
Retained Earnings Increase by | $6960 | $5320 |