Question

The Nelson Company has $1,150,000 in current assets and $460,000 in current liabilities. Its initial inventory level is $330,000, and it will raise funds as additional notes payable and use them to increase inventory. How much can Nelson's short-term debt (notes payable) increase without pushing its current ratio below 1.8? Do not round intermediate calculations. Round your answer to the nearest dollar. $ What will be the firm's quick ratio after Nelson has raised the maximum amount of short-term funds? Do not round intermediate calculations. Round your answer to two decimal places.

Answer 1

Let the increase in inventory and notes payable be x.

Compute the additional notes payable using the equation as shown below:

Current Assets/ Current Liabilities = Current Ratio

($1,150,000 + x) / ( x + $460,000) = 1.8

$1,150,000 + x = 1.8 * ( x + $460,000)

$1,150,000 + x = $828,000 + 1.8x

Solving the above equation:

x = ($1,150,000 - $828,000) / 0.8

x = $402,500

Hence, the maximum notes payable which can be issued to keep the current ratio 1.8 is $402,500.

Compute the quick ratio using the equation as shown below:

Quick Ratio = (Current Ratio - Inventory) / Current Liabilities   

= ($1,150,000 - ($330,000 + $402,500) / ($460,000 + $402,500)

= 0.48:1

Hence, the quick ratio is 0.48:1