Company ABC has total liabilities of $660,000 and total equity of $342,000. The company needs to raise additional funds through debt and equity. The company will issue 12,000 shares of common stock at $15 per share and in addition it intends to borrow as much as it can from Bank of XYZ. Bank of XYZ requires a maximum debt-to-asset ratio of 0.64. What is the maximum additional amount that Company ABC can borrow after the additional stock is issued?

$268,000

Explanation:

GIVEN the following ;

TOTAL LIABILITIES = $660,000

TOTAL EQUITY = $342,000

IN ADDITION:

SHARES TO BE ISSUED = 12,000

PRICE PER SHARE = $15

MAXIMUM LIABILITY ABC CAN BORROW =?

MAXIMUM DEBT-TO-ASSET RATIO = 0.64

TOTAL AMOUNT RAISED FROM BOTH EQUITY AND LIABILITY:

$(660,000 + 342,000 + (12,000 × $15))

$(660,000+342,000+180,000) = $1,182,000

THEREFORE, MAXIMUM LIABILITY WHICH COULD BE ADDED SUCH THAT MAXIMUM-DEBT-ASSET RATIO WILL NOT EXCEED 0.64 CAN BE CALCULATED THUS:

LET MAXIMUM ADDITIONAL LIABILITY = Y

MAXIMUM-DEBT-ASSET RATIO = TOTAL LIABILITY / (TOTAL EQUITY + TOTAL LIABILITY)

0.64 = ($660,000 + Y) / ($1,182,000 + Y)

0.64×($1,182,000+Y) = $660,000 +Y

$756,480 + 0.64Y = $660,000 + Y

0.64Y- Y = $(660,000 - 756,480)

-0.36Y = - $96,480

Y = $268,000

Company ABC Can borrow a maximum of $268,000