Seedly Corporation's most recent balance sheet reports total assets of $35,000,000 and total liabilities of $17,500,000.Management is considering issuing $5,000,000 of par value bonds (at par)with a maturity date of ten years and a contract rate of 7%.What effect,if any,would issuing the bonds have on the company's debt-to-equity ratio?
A)Issuing the bonds would cause the firm's debt-to-equity ratio to improve from 1.0 to 1.3.
B)Issuing the bonds would cause the firm's debt-to-equity ratio to worsen from 1.0 to 1.3.
C)Issuing the bonds would cause the firm's debt-to-equity ratio to remain unchanged.
D)Issuing the bonds would cause the firm's debt-to-equity ratio to improve from .5 to .8.
E)Issuing the bonds would cause the firm's debt-to-equity ratio to worsen from .5 to .8.

Question

Quizplus · Accepted Answer

Debt-to-equity ratio = Total Debt / Total Equity.

Before issuing the bonds:
Debt-to-equity ratio = $17,500,000 / ($35,000,000 - $17,500,000) = 1.0

After issuing the bonds:
Total debt increases by $5,000,000.
Total equity remains the same.
New debt-to-equity ratio = ($17,500,000 + $5,000,000) / ($35,000,000 - $17,500,000) = 1.3

The issuance of bonds will increase the total debt of the company, which would worsen the debt-to-equity ratio. Therefore, the correct answer is B.

Seedly Corporation's Most Recent Balance Sheet Reports Total Assets of $35,000,000