Question

Current and Quick Ratios

The Nelson Company has $1,260,000 in current assets and $450,000 in current liabilities. Its initial inventory level is $300,000, 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 2.0? Do not round intermediate calculations. Round answer to the nearest dollar.

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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 answer to two decimal places.

Answer 1

Let the 'x' be the increase in shortterm debt and increase in inventory at the same time

Target current ratio = Current asset / Current liabilities = 2

So 2 =[ 1260,000 + x] / [ 450,000 + x ]

900,000 + 2x = 1260,000 + x

900,000 + x = 1260,000

So X = 1260,000-900,000 = 360,000

So increase in shortterm debt and increase in inventory at the same time is 360,000

Now will calculate quick ratio after change

Quick ratio = Current asset - Inventory / Current liability

=[ 1260,000+ 360,000 - (300,000+360,000) ] / 450,000+360,000

=960,000 / 810,000

= 1.19