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Problem 7-9 Current and Quick Ratios The Nelson Company has $1,045,000 in current assets and $475,000 in current liabilities
Problem 7-9 Current and Quick Ratios
The Nelson Company has $1,045,000 in current assets and $475,000 in current liabilities. Its initial inventory level is $237,500, 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 1.3? ____________ 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. ____________
Expert Solution
a).
Current Ratio is calculated as: Current Assets/Current Liabilities
Given that the increase in inventory is funded by additional notes payable. So, Current assets and Current liabilities both will increase by same amount.
Let the amount be x. For Current ratio of 1.3, we have,
1.3= (1045000+x)/(475000+x)
617500+1.3x= 1045000+x
0.3x= 427500
x= $1425000.
So, Nelson's short term debt can increase by a maximum of $1425000.00
b).
Quick ratio is calculated as: (Current assets-Inventory)/Current liabilities.
After Nelson raised the short term funds, Current assets= 1045000+1425000= $2470000
Current Liabilities= 475000+1425000= $1900000
Inventory= Initial inventory level+addition= 237500+1425000= $1662500
So, Quick Ratio= (2470000-1662500)/1900000= 0.43
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