Question

Mukhopadhya Network Associates has a current ratio of 1.60, where the current ratio is defined as follows: current ratio = current assets/current liabilities. The firm's current assets are equal to $1,233,265, its accounts payables are $419,357, and its notes payables are $351,663. Its inventory is currently at $721,599. The company plans to raise funds in the short-term debt market and invest the entire amount in additional inventory. How much can notes payable increase without the current ratio falling below 1.40? (Round answer to the nearest whole dollar, e.g. 5,275.) Notes payable can increase by $

Answer 1

Existing Condition

Current ratio = Current assets/ Current liablities

Current assets = 1,233,265

Current liablities = Accounts payable + Notes payable ; ie 419,357 +351,663 =771,020

Substituting values in the equation ,Current ratio = Current assets/ Current liablities

we get

1.6 =1,233,265/771,020

New Condition

The company will raise funds from the short term debt market and use these in inventory

let the amount raised from short term debt market be Y; current ratio should not fall below 1.4

Current ratio = Current assets/ Current liablities

1.4 =(1,233,265 + Y )/(771,020 +Y)

1.4 (771,020 +Y) =(1,233,265 + Y )

1,079,428 + 1.4Y =1,233,265 + Y

1.4Y - Y = 1,233,265 - 1,079,428

0.4Y = 153,837

Y =153,837/0.4

Y =387,592.5

So the company can borrow $387,592.5 from notes payable additionaly to finance in inventory without   the current ratio falling below 1.40