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.

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

jeff jeffy answered 2 years ago

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