Question

The Nelson Company has $1,080,000 in current assets and $400,000 in current liabilities. Its initial inventory level is $280,000, 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 2.5? 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.

Answer 1

Existing current assets=   $1,080,000  
Existing current liabilities=   $400,000  
      
Maintaned current ratio =   2.5  
Assume increase in Inventory and notes payable = X      
      
So New current assets=   $1,080,000   +x
New current liabilities=   $400,000   +x
Current Ratio = Current Assets/Current Liabilities      
2.5 = (1080000+x)/(400000+x)      
1000000+2.5x = 1080000+x      
1.5x =   $80,000  
x=   $53,333.33  
      
So maximum Inventory and notes payable can be increased by   $53,333.33  
      
New current assets =1080000+53333.33=   $1,133,333.33  
New current liabilities= 400000+53333.33=   $453,333.33  
New inventory=280000+53333.33=   333333.33  

quick ratio = (Current Assets - Inventory)/Current liabilities      
(1133333.33- 333333.33)/453333.33      
1.76470589      
      
So New quick ratio is 1.76      

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