Question

# eBook Problem 3-9 Current and Quick Ratios The Nelson Company has \$1,755,000 in current assets and...

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.

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

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