Saffron Industries most recent balance sheet reports total assets of $42,000,000, total liabilities of $16,000,000 and stockholders' equity of $26,000,000. Management is considering using
$3,000,000 of excess cash to prepay $3,000,000 of outstanding bonds. What effect, if any, would prepaying the bonds have on the company's debt-to-equity ratio?
A) Prepaying the debt would cause the firm's debt-to-equity ratio to remain unchanged.
B) Prepaying the debt would cause the firm's debt-to-equity ratio to improve from .62 to .50.
C) Prepaying the debt would cause the firm's debt-to-equity ratio to worsen from .62 to .57.
D) Prepaying the debt would cause the firm's debt-to-equity ratio to worsen from .62 to .50.
E) Prepaying the debt would cause the firm's debt-to-equity ratio to improve from .62 to .57.

Question

Quizplus · Accepted Answer

Prepaying the debt would reduce total liabilities by $3,000,000, which would improve the debt-to-equity ratio. The new debt-to-equity ratio would be $13,000,000/$26,000,000 = 0.50.

Saffron Industries Most Recent Balance Sheet Reports Total Assets of $42,000,000