June Smith, a process engineer, has sold her 15-year patent for a new etching process to Silica
Labs, Inc. In return, she has received $500,000 in cash and, based on its value on the sale
date, $200,000 in common stock in Silica Labs. The stock is forecasted to double in market
value over the next two months.
Assuming that Silica Labs holds some long-term debt, which of the following describes the
effect of the transaction on Silica Labs?
A. Current ratio will decrease and total debt to equity ratio will increase
B. Current ratio will increase and total debt to equity ratio will increase
C. Current ratio will decrease and total debt to equity ratio will decrease
D. Current ratio will increase and total debt to equity ratio will decrease

***My answer: I am kind of lost on this one. I think I would narrow my choices down to the selections that have the current ratio increasing because I believe Silica labs is gaining an asset that costs 700k and only really paying 500k of assets so the current ratio would increase because current ratio = current assets/current liabilities.
Next I would choose the selection that would show the debt to equity ratio increasing. I think I am so far off on this and need help please!

It's helpful to break it down by considering each component in isolation...

• The addition of the patent to the noncurrent assets on the balance sheet has no effect on current assets, current debt, equity, nor long-term debt.

• The payment of cash by Silica decreases current assets.

• The issuance of stock increases Silica's total equity.

Recap:
• Debiting the Patent onto the balance sheet affects neither ratio.
• Crediting Cash reduces the numerator of the current ratio.
• Crediting Stock increases the denominator of the debt : equity ratio.

Only one of the 4 answer choices corresponds to these effects.

Just for fun, can you see why they had to add the assumption that Silica has some LT debt outstanding?

It's helpful to break it down by considering each component in isolation...

• The addition of the patent to the noncurrent assets on the balance sheet has no effect on current assets, current debt, equity, nor long-term debt.

• The payment of cash by Silica decreases current assets.

• The issuance of stock increases Silica's total equity.

Recap:
• Debiting the Patent onto the balance sheet affects neither ratio.
• Crediting Cash reduces the numerator of the current ratio.
• Crediting Stock increases the denominator of the debt : equity ratio.

Only one of the 4 answer choices corresponds to these effects.

Just for fun, can you see why they had to add the assumption that Silica has some LT debt outstanding?

Ok, so because the numerator in the current ratio is decreased that would make the current ratio decrease as well. And then by increasing the denom of the debt/equity ration you are also decreasing the ratio. So tha answer would be C: current ratio will decrease and total debt to equity ratio will decrease! Correct?

Quite correct... good job. I'd enjoy sticking and playing with the other questions, but other obligations are pressing.

The "just for fun" answer, though, is that with NO long-term debt outstanding, Silica's debt-to-equity ratio would be (0 / equity) = zero, which wouldn't change no matter what changes to the denominator might occur (other than going to zero itself, in which case the ratio would be undefined).

Take care, and best of success with the studies.

Quite correct...good job. I'd enjoy sticking and playing with the other questions, but other obligations are pressing.

The "just for fun" answer, though, is that with NO long-term debt outstanding, Silica's debt-to-equity ratio would be (0 / equity) = zero, which wouldn't change no matter what changes to the denominator might occur (other than going to zero itself, in which case the ratio would be undefined).

Take care, and best of success with the studies.

Ahhh, my apologies I never saw the just for fun question. That's interesting and I get it thanks for the extra lesson! :)