Question

XYZ Corp. has current assets of $8 million, current liabilities of $2 million, cash of $4 million, accounts receivable of $3 million, and inventory of $1 million. XYZ has decided to use $2 million of its cash to buy additional inventory. Which of the following ratios will change as a result of this move?

		Total Asst Turnover
		All of the above
		Current Ratio
		Quick Ratio

Answer 1

Only Quick ratio will be affected by this decision of using $2 mn cash to buy inventory because in the other two ratios total asset base is not going to change.

Total asset turnover is = Sales/Average assets, even if we purchase inventory by cash, assets are not going to change so this ratio won't be affected

Current ratio = Current Assets/Current liabilities, again current assets are not going to change so this ratio will be constant

Now Quick ratio = Current assets - Inventory/ Current liabilities

Initially, 8-1/2= 3.5

Now after the decision of buying inventory worth $2mn, total inventory will be $3 mn

now it be 8-3/2 = 2.5

So only this ratio will be affected