Question

2- Current and Quick Ratios

The Nelson Company has $1,650,000 in current assets and $550,000 in current liabilities. Its initial inventory level is $385,000, and it will raise funds as additional notes payable and use them to increase inventory.

A) 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. $

B) 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 Asset = $1650000

Current liabilities= 550,000

Let Short term debt and increase in inventory = x

Current ratio = Current Asset / Current liabilities

1.2 = (1650,000+x) / (550,000 + x)

By cross multiplication

1.2 * (550,000 + x) = 1650,000 + x

660,000 + 1.2 x = 1650,000 + x

1.2x - x = 1650,000 - 660,000

x = 990,000 / 0.20

x = 4950,000

So, Short term debt and inventory has to be increased by 4950,000 to keep current ratio 1.2.

B) Current Asset = $1650,000

Inventory = $385,000 + 4950,000

= 5335,000

Current Liabilities after raising short term debt = 550000 + 4950,000

= 5500,000

Quick ratio = (Current asset - Inventory) / Current liabilites

= (6600000 -5335000) / 5500000

= 0.23

Quick ratio = 0.23