Question

The Nelson Company has $1,444,500 in current assets and $535,000 in current liabilities. Its initial inventory level is $405,000, 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

1) Current ratio = ($1,444,500 + ∆NP) / ($535,000 + ∆NP) = 1.8

($1,444,500 + ∆NP) = 1.8($535,000 + ∆NP)

$1,444,500 + ∆NP = $963,000 + 1.8∆NP

$1,444,500 - $963,000 = 1.8∆NP - ∆NP

∆NP = $601,875

The maximum increase in short-term debt (notes payable) without pushing its current ratio below 1.8 would be $601,875.

2) Current assets = $1,444,500 + $601,875 = $2,046,375

Current liabilities = $535,000 + $601,875 = $1,136,875

Since we assumed that the additional funds would be used to increase inventory,the inventory account will increase to $1,006,875

Quick ratio = (Current assets - Inventory) / Current liabilities

Quick ratio = ($2,046,375 - $1,006,875) / $1,136,875

Quick ratio = 0.91