Jones Inc. has a capital structure consisting of $8 million of liabilities and $10 million of equity. Included in liabilities is $1.2 million worth of exchangeable bonds. Immediately afterwards, Jones issues $0.7 million of redeemable preferred shares for cash proceeds and also calls its entire group of exchangeable bonds, netting a gain of $0.3 million on the bonds. Which of the following amounts is Jones’ revised debt to total capital ratio upon completion of the two new transactions? A) 0.458. B) 0.728. C) 0.845. D) 0.421.
Well, what did you calculate?
A = L + E 18 = 8 + 10 ==> Issuing new preffered Equity for 0.7 18+0.7 = 8 + 10.7 ==> Retiring debt with 0.3 m profit. 18.7 - 0.9 = (L=8-1.2) + (Equity=10.7+0.3) => (Asset=)17.8 = (Liability=)6.8 + (Equity=)11 ==> I get 6.8/17.8 == 0.382. It seems Toal Debt / Total Capital ratio to me though. But I am not sure how can i extract only Long term debt from the the information provided.
I think they want you to use L as a proxy for LTD. That’s just one problem with this question. They don’t tell you whether 1.2 is book or market value; they don’t indicate whether to calculate Debt (for the ratio) using bk or mkt. So the question is fairly crappy, feel free to move on. However you need drop E by 0.9 (rather than adding 0.3) – it seems they paid 0.9 (market) for 1.2 (book) worth of bonds. That might get you to the .42 answer.
If they paid 0.9 to market , how does equity change? It will drop the cash by 0.9, reduce the liability by 1.2 & gains of 0.3 will increase NI & hus retained earnings & equity. Am I missing something?
Here is the answer from schweser: D The $0.7 million of redeemable preferred shares are treated as debt and will increase liabilities. The exchange of the bonds results in a decrease in liabilities of $1.2 million and a gain of $0.3 million. The latter results in an increase in equity by $0.3 million (the net effect of the two transactions also decreases assets by $0.9 million). Liabilities = $8 million + $0.7 million - $1.2 million = $7.5 million Equity = $10 million + $0.3 million = $10.3 million Debt to total capital ratio = Liabilities / (Liabilities + Equity) = $7.5 million / ($7.5 million + $10.3 million) = 0.421.