Question

Current and Quick Ratios

The Nelson Company has $1,485,000 in current assets and $495,000 in current liabilities. Its initial inventory level is $365,000, 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 1.8? Do not round intermediate calculations. Round your answer to the nearest dollar.

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What will be the firm's quick ratio after Nelson has raised the maximum amount of short-term funds? Do not round intermediate calculations. Round your answer to two decimal places.

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Answer 1

Answer to Part 1:
Required Current Ratio = 1.8

Existing Current Assets = $1,485,000
Existing Current Liabilities = $495,000

Let the Increase in Short Term Debt be “$x” which is used to increased Inventory.

Current Ratio = Current Assets / Current Liabilities
1.80 = ($1,485,000 + $x) / ($495,000 + $x)
1.80 * ($495,000 + $x) = $1,485,000 + $x
$891,000 + $1.80x = $1,485,000 + $x
$594,000 = $0.80x
$x = $742,500

The Increase in Short term debt without pushing its current ratio below 1.80 is $742,500.

Answer to Part 2:
Proposed Inventory = $365,000 + $742,500
Proposed Inventory = $1,107,500

Proposed Current Assets = $1,485,000 + $742,500
Proposed Current Assets = $2,227,500

Proposed Current Liabilities = $495,000 + $742,500
Proposed Current Liabilities = $1,237,500

Quick ratio = (Current Assets – Inventory)/ Current Liabilities
Quick ratio = ($2,227,500 - $1,107,500) / $1,237,500
Quick ratio = $1,120,000 / $1,237,500
Quick ratio = 0.91