Question

Composite Solutions Company (CSC) has the following account balances:

Current assets	$	29,000	Current liabilities	$	10,000
Noncurrent assets		89,000	Noncurrent liabilities		58,000
			Stockholders’ equity		50,000

The company wishes to raise $45,000 in cash and is considering two financing options: CSC can sell $45,000 of bonds payable, or it can issue additional common stock for $45,000. To help in the decision process, CSC’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 CSC’s management. (Round your answers to 2 decimal places.)

a-2.	Compute the debt to assets ratio for CSC’s management. (Round your answers to 1 decimal place.)

b.	Assume that after the funds are invested, EBIT amounts to $19,400. 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 iretained earnings that would result under each financing option.

      

Answer 1

	Current Assets	Total Assets	Current Liabilites	Total Liabilities
Situation Currently	$29,000	$118,000	$10,000	$68,000(10000+58000)
Raise Money:
Using Bonds	$74,000(29000+45000)	$163,000(89000+74000)	$10,000	$113,000(10000+58000+45000)
Using Stock	$74,000	$163,000	$10,000	$68,000
Current Ratio Currently ($29,000/$10,000)				2.9
Debt to Assets Ratio Currently($68,000/$118,000)				0.6
Current Ratio if bonds are issued($74,000/$10,000)				7.4
Debt to Assets Ratio if bonds are issue($113,000/$163,000)				0.7
Current Ratio if stocks are issued($74,000/$10,000)				7.4
Debt to Assets Ratio if stocks are issue($68,000/$163,000)				0.4

b)

	if pay Dividends	if pay Interest
EBIT	$19,400	$19,400
Less:Interest	$0	$4,100
Earnings Before Tax	$19,400	$15,300
Less:Tax @40%	$7,760	$6,120
Earnings After Tax	$11,640	$9,180
Less:Dividend Payment	$4,100	$0
Retained Earnings	$7,540	$9,180