Question

The Nelson Company has $1,687,500 in current assets and $675,000 in current liabilities. Its initial inventory level is $405,000, and it will raise funds as additional notes payable and use them to increase inventory.

1. How much can Nelson's short-term debt (notes payable) increase without pushing its current ratio below 1.7? Round your answer to the nearest cent.

   $  

2. 
   
3. 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

Answer to Part 1.

Before financing:

Current Assets = $1,687,500
Current Liabilities = $675,000

After financing:

Let the amount raised through Short-Term Notes Payable be “$x”

Current Assets = $1,687,500 + $x
Current Liabilities = $675,000 + $x

Current Ratio = Current Assets / Current Liabilities
1.7 = ($1,687,500 + $x) / ($675,000 + $x)
$1,147,500 + $1.7x = $1,687,500 + $x
$0.7x = $540,000
$x = 771,428.57

Therefore, Nelson should raise $771,428.57 by issuing Short-term note without pushing Current ratio below 1.7.

Answer to Part 2.

After financing:

Proposed Inventory = $405,000 + $771,428.57
Proposed Inventory = $1,176,428.57

Proposed Current Assets = $1,687,500 + $771,428.57
Proposed Current Assets = $2,458,928.57

Proposed Current Liabilities = $675,000 + $771,428.57
Proposed Current Liabilities = $1,446,428.57

Quick Ratio = (Current Assets - Inventory) / Current Liabilities
Quick Ratio = ($2,458,928.57 - $1,176,428.57) / $1,446,428.57
Quick Ratio = 0.89