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.
B) Issuing the bonds would cause the firm's debt-to-equity ratio to worsen from 1.0 to 1.3.
Explanation: Current Situation:
Total Assets = Total Liabilities + Stockholders' Equity
35,000,000 = 17,500,000 + 17,500,000
Debt-to-equity ratio = 17.5/17.5 or 1.0.
If debt is issued:
Total Assets = Total Liabilities + Stockholders' Equity
40,000,000 = 22,500,000 + 17,500,000
Debt-to-equity ratio = 22.5/17.5 or 1.3.
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