Clayton Industries has the following account balances:

Current assets ................................................$20,000 

Current liabilities........................................... $10,000
Noncurrent assets ..........................................80,000 

Noncurrent liabilities .....................................50,000
Stockholders’ equity ......................................40,000

The company wishes to raise $40,000 in cash and is considering two financing options: Clayton can sell $40,000 of bonds payable, or it can issue additional common stock for $40,000. To help in the decision process, Clayton’s management wants to determine the effects of each alternative on its current ratio and debt-to-assets ratio.

Required
a. Help Clayton’s management by completing the following chart:

b. Assume that after the funds are invested, EBIT amounts to $12,000. Also assume the company
pays $4,000 in dividends or $4,000 in interest depending on which source of financing is used.
Based on a 30 percent tax rate, determine the amount of the increase in retained earnings that
would result under each financing option.

Transcribed Image Text:

If Bonds Are Issued If Stock Is Issued Ratio Currently Current ratio Debt-to-assets ratio