Effects of Financing Decisions (LO2, 5)

Provo Company has total assets of $2,500,000 and total liabilities of $2,000,000. Provo is considering two alternatives for acquiring additional warehouse space. Under the first alternative, the building would be purchased for $300,000 and financed by issuing long-term bonds. Under the second alternative, the building would be rented with an annual lease cost of $30,000 per year.

Required

a. Compute the company’s current debt-to-equity ratio.

b. What effect would the addition of warehouse space have on its debt-to-equity ratio 1. Assuming the building is purchased by issuing bonds?

2. Assuming the building is rented on an annual lease basis?

 LO.1