Question

2. If ZZBest Corp. has current assets of $24 million and current liabilities of $15 million...

2. If ZZBest Corp. has current assets of $24 million and current liabilities of $15 million what is the impact on the current ratio of the following transactions? Each situation is independent. a. Purchase of inventory costing $2 million on credit. b. Sell inventory costing $2 million for a sales price of $3 on credit. c. Borrowing $10 million in cash from bank that will be repaid in 5 years. d. Pay cash for a prepaid insurance policy costing $1 million and covering one year. e. Pay cash for rent expense of $1 million.

Required: For each transaction indicate whether the current ratio went up or down or stayed the same and why (i.e. change in current assets, liabilities, etc.)

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Answer #1

Current ratio before the transaction = $ 24 million / $ 15 million = 1.60

No. Transaction Impact on Current Ratio New Current Ratio
a. Purchase of Inventory costing $ 2 million on credit Decrease $ ( 24 + 2 ) million / $ (15 + 2) million = 1.53
b. Sell inventory costing $ 2 million for a sale price of $ 3 million on credit Increase $ ( 24 - 2 + 3 ) million / $ 15 million = 1.67
c. Borrowing $ 10 million in cash from bank that will be repaid in 5 years Increase $ ( 24 + 10 ) / $ 15 million = 2.27
d. Pay cash for a prepaid insurance policy costing $ 1 million and covering one year No change $ ( 24 - 2 + 2 ) / $ 15 = 1.60
e. Pay cash for rent expense of $ 1 million Decrease $ ( 24 - 1 ) million / $ 15 million = 1.53
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