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

Alessandro Da Silva Santos · Accepted Answer

Final Answer : B, Explanation :  Before issuing the bonds, Seedly Corporation's equity can be calculated as total assets minus total liabilities, which is $35,000,000 - $17,500,000 = $17,500,000. The debt-to-equity ratio is total liabilities divided by total equity, which initially is $17,500,000 / $17,500,000 = 1.0. After issuing $5,000,000 of bonds, total liabilities increase to $22,500,000. The new debt-to-equity ratio becomes $22,500,000 / $17,500,000 = 1.2857, which rounds to approximately 1.3. Therefore, issuing the bonds worsens the debt-to-equity ratio from 1.0 to 1.3.

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