Question
In: Finance
The Nelson Company has $1,667,500 in current assets and $575,000 in current liabilities.
Problem 7-9
Current and Quick Ratios
The Nelson Company has $1,667,500 in current assets and $575,000 in current liabilities. Its initial inventory level is $287,500, 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.
Solutions
Expert Solution
| Existing current ratio | Current assets/Current liabilities | ||||||
| Existing current ratio | 1667500/575000 | ||||||
| Existing current ratio | 2.90 | ||||||
| Minimum current ratio | (Current assets + Change in notes payable)/(Current liabilities + Change in notes payable) | ||||||
| 1.3 | (1667500 + Change in notes payable)/(575000 + Change in notes payable) | ||||||
| 1.3*(575000+Change in notes payable) | (1667500 + Change in notes payable) | ||||||
| 747500 + 1.3Change in notes payable | (1667500 + Change in notes payable) | ||||||
| 0.3Change in notes payable | 1667500-747500 | ||||||
| 0.3Change in notes payable | 920000 | ||||||
| Change in notes payable | 920000/0.3 | ||||||
| Change in notes payable | $3,066,666.67 | ||||||
| Thus, short term debt increase could be $3,066,666.67 | |||||||
| Assuming additional note raised is for purchase of inventory | |||||||
| Quick ratio | (Current assets - Inventory)/Current liabilities | ||||||
| Quick ratio | (4734166.67 - (287500+3066666.67))/(575000+3066666.67) | ||||||
| Quick ratio | 1380000/3641666.67 | ||||||
| Quick ratio | 0.38 | ||||||
| Thus, quick ratio would be 0.38 times | |||||||
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