Question

"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?"

Answer 1

Answer:

Debt to equity will increase from 1 to 1.286 following the issue of the bonds.

Explanation:

We have Seedly Corporation's balance sheet before the issuing of $5,000,000 million bond consists of: $35,000,000 Asset; $17,500,000 Liabilities; $17,500,000 Owner's Equity ( i.e: Total asset - Total liabilities = 35 million - 17.5 million). Thus, Debt-to-equity ratio = Total debt/Total equity = $17.5 million/ $17.5 million = 1;

We have Seedly Corporation's balance sheet after the issuing of $5,000,000 million bond consists of: $40,000,000 Asset ( i.e to include the 5,000,000 proceed received from bond issue); $22,500,000 Liabilities ( i.e to include the 5,000,000 liabilities recorded from bond issue); $17,500,000 Owner's Equity ( i.e: Total asset - Total liabilities = 40 million - 22.5 million). Thus, Debt-to-equity ratio = Total debt/Total equity = $22.5 million/ $17.5 million = 1.286.