Effects of different forms of financing on financial ratios
The following condensed balance sheet for December 31, 2012, comes from the records of Buzz and Associates:
|
Assets |
Liabilities and Shareholders” Equity |
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|
Cash |
$ 10.0011 |
Current liabilities |
$ 20000 |
|
Other current assets |
40.000 |
Long-term notes payable |
20000 |
|
Property. plant, and equipment |
70.009 |
Contributed capital |
30000 |
|
Retained earnings |
50000 |
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|
Total liabilities and |
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|
Total assets |
$120.000 |
shareholders” equity |
120000 |
Buzz and Associates is considering the purchase of a new piece of equipment for $30,000. The company does not have enough cash to purchase it outright, so it is considering alternative ways of financing. As management sees it, there are three basic options: (1) issue 3,000 ownership shares for $10 per share, (2) take out a long-term loan (12 percent annual interest) for $30,000 from the bank, or (3) purchase the equipment on open account (must be paid in full in thirty days). Presently Buzz has 12,000 ownership shares outstanding.
REQUIRED:
a. Compute the present current ratio (current assets/current liabilities), the debt/equity ratio (total liabilities/shareholders” equity), and the book value of Buzz”s outstanding ownership shares: (total assets minus total liabilities) divided by number of shares outstanding.
b. Compute the current ratio, debt/equity ratio, and book value per share under each of the three financing alternatives, and express your answers in the following format:
|
Financing Alternative |
Current Ratio |
Debt/Equity Ratio |
Book Value per Share |
|
1. Share issuance |
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2. Long-term note |
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3. open account |
c. Discuss some of the pros and cons associated with each of the three financing options.
d. The chairman of the board of directors stated at a recent board meeting that with $50,000 in Retained Earnings, the company should be able to purchase the $30,000 piece of equipment. Comment on the chairman”s statement.