Question

Your firm successfully issued new debt last year, but the debt carries covenants. Specifically, you can only pay dividends out of earnings made after the debt issue and you must maintain a minimum quick (acid-test) ratio left parenthesis Current Assets minus Inventory right parenthesis divided by Current Liabilities(Current Assets?Inventory)/Current Liabilities of 1.1. Your net income this year was $69.9 million. Your cash is $10.2 million, your receivables are $8.1 million, and your inventory is $4.6 million. You have current liabilities of $19.5 million. What is the maximum dividend you could pay (in cash and in stock) this year and still comply with your covenants?

The maximum dividend would be_______ $ million. (Round to one decimal place.)

*please explain steps, specifically how to increase the quick ratio to 1.1*

Answer 1

Quick ratio = (Current Assets - Inventory) / Current Liabilities

= $18.3 million / $19.5 million = 0.94

According to the covenants, Quick Ratio should equal to 1.1

So, to increase the quick ratio we can pay off current liabilities from Net income earned during the year

New current liabilities = (Current Assets - Inventory) / Minimum Quick Ratio

= $18.3 million / 1.1 = $16.6 Million

so, net decrease in Current Liabilities = $19.5 million - $16.6 million = $2.9 million

$2.9 million will be paid from net income.

The maximum dividend = $69.9 million - $2.9 million = $67 million.