Tart Company's 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 improve from .62 to .50.
B)Prepaying the debt would cause the firm's debt-to-equity ratio to improve from .62 to .57.
C)Prepaying the debt would cause the firm's debt-to-equity ratio to worsen from .62 to .50.
D)Prepaying the debt would cause the firm's debt-to-equity ratio to worsen from .62 to .57.
E)Prepaying the debt would cause the firm's debt-to-equity ratio to remain unchanged.

Question

Quizplus · Accepted Answer

Current Situation: Total Assets = Total Liabilities + Stockholders' Equity
42,000,000 = 16,000,000 + 26,000,000
Debt-to-equity ratio = 16 / 26 or .62.
If debt is prepaid: Total Assets = Total Liabilities + Stockholders' Equity
39,000,000 = 13,000,000 + 26,000,000
Debt-to-equity ratio = 13 / 26 or .50.

Tart Company's Most Recent Balance Sheet Reports Total Assets of $42,000,000,total