Saffron Industries most recent balance sheet reports total assets of $42,000,000,total liabilities of $16,000,000 and stockholders' equity of $26,000,000.Management is considering using $3,000,000 of excess cash to prepay $3,000,000 of outstanding bonds.What effect,if any,would prepaying the bonds have on the company's debt-to-equity ratio?
A)Prepaying the debt would cause the firm's debt-to-equity ratio to improve from .62 to .50.
B)Prepaying the debt would cause the firm's debt-to-equity ratio to improve from .62 to .57.
C)Prepaying the debt would cause the firm's debt-to-equity ratio to worsen from .62 to .50.
D)Prepaying the debt would cause the firm's debt-to-equity ratio to worsen from .62 to .57.
E)Prepaying the debt would cause the firm's debt-to-equity ratio to remain unchanged.

Question

Quizplus · Accepted Answer

Prepaying the debt reduces total liabilities from $16,000,000 to $13,000,000 and reduces assets (due to the use of cash) to $39,000,000. The new debt-to-equity ratio is $13,000,000 / $26,000,000 = 0.5, which is an improvement from the initial ratio of $16,000,000 / $26,000,000 = 0.615 (approximated to .62 in the question).

Saffron Industries Most Recent Balance Sheet Reports Total Assets of $42,000,000,total