Question
In: Accounting
Clayton Industries has the following account balances: Current assets $ 25,000 Current liabilities $ 15,000 Noncurrent...
Clayton Industries has the following account balances:
| Current assets | $ | 25,000 | Current liabilities | $ | 15,000 | |
| Noncurrent assets | 79,000 | Noncurrent liabilities | 46,000 | |||
| Stockholders’ equity | 43,000 | |||||
The company wishes to raise $41,000 in cash and is considering two
financing options: Clayton can sell $41,000 of bonds payable, or it
can issue additional common stock for $41,000. 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.
Compute the current ratio for Clayton’s management currently, if
bonds are issued, and if stock is issued. (Round your
answers to 2 decimal places.)
Compute the debt-to-assets ratio for Clayton’s
management. (Round your answers to 1 decimal
place.)
Assume that after the funds are invested, EBIT amounts to
$17,200. Also assume the company pays $3,400 in dividends or $3,400
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.
Solutions
Expert Solution
(i)
Current assets = 25,000 + 41,000
= $66,000
Current ratio = Current assets/Current liabilities
= 66,000/15,000
= 4.4
Current ratio will be same whether funds are raised through bonds or stock
(ii)
When funds are raised by bonds
Debt = Current liabilities + Non current liabilities + Bonds
= 15,000 + 46,000 + 41,000
= $102,000
Total assets = Current assets + Non current assets + Cash
= 25,000 + 79,000 + 41,000
= $145,000
Debt to assets ratio = Debt/Total assets
= 102,000/145,000
= 0.7
When funds are raised by stock
Debt = Current liabilities + Non current liabilities
= 15,000 + 46,000
= $61,000
Total assets = Current assets + Non current assets + Cash
= 25,000 + 79,000 + 41,000
= $145,000
Debt to assets ratio = Debt/Total assets
= 61,000/145,000
= 0.4
(iii)
| Funds raised by bonds | Funds raised by stock | |
| EBIT | 17,200 | 17,200 |
| Interest | - 3,400 | 0 |
| EBT | 13,800 | 17,200 |
| Tax | - 5,520 | - 6,880 |
| EAT | 8,280 | 10,320 |
| Dividend | 0 | - 3,400 |
| Increase in retained earnings | $8,280 | $6,920 |
ekkarill92 answered 10 months agoRelated Solutions
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