Accounting Midterm Exam ACG-2011: Question 89

Pitt 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?

	Issuing the bonds would cause the firm's debt-to-equity ratio to improve from .5 to .8.
	Issuing the bonds would cause the firm's debt-to-equity ratio to improve from 1.0 to 1.3.
→	Issuing the bonds would cause the firm's debt-to-equity ratio to worsen from 1.0 to 1.3.
	Issuing the bonds would cause the firm's debt-to-equity ratio to remain unchanged.
	Issuing the bonds would cause the firm's debt-to-equity ratio to worsen from .5 to .8.

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.