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Problem 3-9
Current and Quick Ratios

The Nelson Company has $1,687,500 in current assets and $675,000 in current liabilities. Its initial inventory level is $472,500, and it will raise funds as additional notes payable and use them to increase inventory.

1. How much can Nelson's short-term debt (notes payable) increase without pushing its current ratio below 1.8? Round your answer to the nearest cent.

   $  

2. 
   
3. What will be the firm's quick ratio after Nelson has raised the maximum amount of short-term funds? Round your answer to two decimal places.

Answer 1

1) Current ratio = Current assets/ current liabilities =1.8 (given maximum)

Let Nelson's short-term debt (notes payable) be increased by "X" amount

So the current assets then will be "1,687,500 + X"

the current Liabilities then will be "675,000 +X"

So by the problem,

Current ratio = (1,687,500 + X) / (675,000 +X) =1.8

or, 1,687,500 + X = 1215000 + 1.8X

or, 472500 = 0.8X

X = 590625

So Nelson's short-term debt (notes payable) can increase by $ 590625.00 ( Answer)

2)Present current asset = 1,687,500 + 590625 = $ 2278125

Present current liabilities= 675,000 + 590625 = $ 1265625

Inventory = $ 472,500

Quick ratio = (Current asset - inventory)/ (Current liability)

= (2278125 - 472,500) / (1265625)

= 1.43 (Answer)