Question

eBook Problem 3-9 Current and Quick Ratios The Nelson Company has $1,755,000 in current assets and $650,000 in current liabilities. Its initial inventory level is $325,000, 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 1.2? Round your answer to the nearest cent. $ 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

a)
Current ratio = Current assets / current liabilities

1.2 = ($1,755,000 + X) / ($650,000 + X)

1.2 * ($650,000 + X) = $1,755,000

$780,000 + 1.2X = $1,755,000 + X

1.2X - X = $1,755,000 - $780,000

0.20X = $950,000

X = $950,000 / 0.20 = $4,875,000

X = $4,875,000

Nelson's short-term debt (notes payable) can increase by $4,875,000 without pushing its current ratio below 1.2.

b)
Quick ratio = (Current assets - inventory) / current liabilities

Total inventory = ($4,875,000 + $325,000) = $5,200,000

New current assets = $1,755,000 + $4,875,000 = $6,630,000

New current liability = $650,000 + $4,875,000 = $5,525,000

New quick ratio = (Current assets - inventory) / Current liabilities
= ($6,630,000 - $5,200,000) / $5,525,000
= $1,430,000 / $5,525,000
= 0.26

New quick ratio = 0.26