Question

The Nelson Company has $1,406,500 in current assets and $485,000 in current liabilities. Its initial inventory level is $330,000, 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 2.0? 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.

Answer 1

Present Current Ratio = Current Assets / Current Liabilities

= $1,406,500 / $485,000 = 2.9

Subsitute 2 times for minimum current ratio, $1,406,500 for Current Assets and $485,000 for current liabilities.

Minimum Current ratio = Current Assets + Notes payable / Current Liabilities + Notes payable

2.0 = $1,406,500 + Notes payable / $485,000 + Notes payable

$1,406,500 + Notes payable = 2.0 ($485, 000 + Notes payable)

$1,406,500 + Notes payable= $970,000 + 2 Notes payable

Notes payable = $436,500

NOTE:Short term debt can increase by a maximum of $436,500 without violating current ratio.

Assuming that the entire increase in notes payable is used to increase current assets. We assume that the additional funds would be used to increase inventory, the inventory account will increase to $766,500($330,000 + $436,500) , and current assets will total $1,843,000 ($1,406,500 + $436,500) and current liabities $921,500($485,000 + $436,500) .

Quick Ratio = ( Current Assets - Inventory) / Current Liabilities

Quick Ratio = ($1,843,000 - $766,500) / $921,500

Quick Ratio = $1,076,500/ $921,500 = 1.16 Times