Question
In: Accounting
Clayton Industries has the following account balances: Current assets $ 24,000 Current liabilities $ 6,000 Noncurrent...
Clayton Industries has the following account balances:
| Current assets | $ | 24,000 | Current liabilities | $ | 6,000 | |
| Noncurrent assets | 82,000 | Noncurrent liabilities | 40,000 | |||
| Stockholders’ equity | 60,000 | |||||
The company wishes to raise $37,000 in cash and is considering two
financing options: Clayton can sell $37,000 of bonds payable, or it
can issue additional common stock for $37,000. 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 currently, if bonds are issued, if stock is issued.
a-2. Compute the debt-to-assets ratio for Clayton’s management currently, if bonds are issued, if stock is issued.
Assume that after the funds are invested, EBIT amounts to $13,100. Also assume the company pays $4,400 in dividends or $4,400 in interest depending on which source of financing is used. Based on a 30 percent tax rate, determine the amount of the increase in retained earnings that would result under each financing option.(bonds, stocks)
Solutions
Expert Solution
a-1)
Current assets after issue of bonds or stock will increase by $37,000. Hence, current ratio will remain same whether funds are raised by issue of bonds or stock
Hence, current assets = 24,000 + 37,000
= $61,000
Current ratio = Current assets/Current liabilities
= 61,000/6,000
= 10.17
a-2)
(i) When funds are raised by issuing bonds
Debt = Current liabilities + Non current liabilities
= 6,000 + (40,000 + 37,000)
= 6,000 + 77,000
= $83,000
Total assets = Current assets + Non current assets
= (24,000 + 37,000) + 82,000
= 61,000 + 82,000
= $143,000
Debt to assets ratio = Debt/Total assets
= 83,000/143,000
= 0.58
(ii) When funds are raised by issuing stock
Debt = Current liabilities + Non current liabilities
= 6,000 + 40,000
= $46,000
Total assets = Current assets + Non current assets
= (24,000 + 37,000) + 82,000
= 61,000 + 82,000
= $143,000
Debt to assets ratio = Debt/Total assets
= 46,000/143,000
= 0.32
| Bonds option | Stock option | |
| EBIT | 13,100 | 13,100 |
| Less: Interest | - 4,400 | 0 |
| EBT | 8,700 | 13,100 |
| Tax | - 2,610 | - 3,930 |
| Earnings after tax | 6,090 | 9,170 |
| Dividend | 0 | - 4,400 |
| Increase in retained earnings | $6,090 | $4,770 |
ekkarill92 answered 4 months agoRelated Solutions
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