Question

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Clayton Industries has the following account balances: Current assets $ 24,000 Current liabilities $ 11,000 Noncurrent...

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

Solutions

Expert Solution

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

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

ekkarill92 answered 1 year ago

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