An entity sells an equal dollar amount of convertible preferred stock and long-term notes payable.Prior to these transactions,total debt was less than total equity.How did the sale of the convertible preferred stock and the long-term notes payable affect the company's debt to total assets ratio?
A) The debt to total assets ratio would decrease.
B) The debt to total assets ratio would increase.
C) The debt to total assets ratio would remain the same.
D) The effect on the debt to total assets ratio cannot be determined from the information given.

Question

Quizplus · Accepted Answer

The sale of long-term notes payable increases the company's total debt, while the sale of convertible preferred stock increases equity. Since the question specifies an equal dollar amount for both, the increase in total assets (due to both debt and equity increasing by the same amount) does not proportionally affect the ratio as much as the increase in debt does. Therefore, the debt to total assets ratio increases because the numerator (total debt) increases while the denominator (total assets) also increases, but the impact on the ratio is more significant due to the increase in debt.

An Entity Sells an Equal Dollar Amount of Convertible Preferred