Question

Current and Quick Ratios

The Nelson Company has $1,312,500 in current assets and $525,000 in current liabilities. Its initial inventory level is $360,000, 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 2.2? 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 = ($1,312,500 + ∆NP) / ($525,000 + ∆NP) = 2.2

($1,312,500 + ∆NP) = 2.2($525,000 + ∆NP)

$1,312,500 + ∆NP = $1,155,000 + 2.2∆NP

$1,312,500 - $1,155,000 = 2.2∆NP - ∆NP

∆NP = $131,250

The maximum increase in short-term debt (notes payable) without pushing its current ratio below 2.2 would be $131,250.

2) Current assets = $1,312,500 + $131,250 = $1,443,750

Current liabilities = $525,000 + $131,250 = $656,250

Since we assumed that the additional funds would be used to increase inventory,the inventory account will increase to $491,250.

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

Quick ratio = ($1,443,750 - $491,250) / $656,250

Quick ratio = 1.45