Question

(Risk return trade-off) CL Marshall Liquors owns and operates a chain of beer and wine shops throughout the Dallas-Fort Worth metroplex. The rapidly expanding population of the area has resulted in the firm requiring a growing amount of funds. Historically, the firm has reinvested earnings and borrowed using short-term bank notes. Balance sheets for the last 5 years are found in the popup window: b. Alter the financial statements above such that current liabilities remain constant at $ 60 and long-term liabilities increase in the amount needed to meet the firm's financing requirements. Compute the firm's current ratio (current assets divided by current liabilities) and the firm's debt ratio (current plus long-term liabilities divided by total assets) using the following revised financial statements, you have prepared for the 5-year period 2011long dash 2015. Describe the firm's risk using both the current ratio and debt ratio. c. Which of the financing plans is more risky? Why? 2011 2012 2013 2014 2015 Current assets 130 160 190 220 250 Fixed assets 260 280 300 320 340 Total 390 440 490 540 590 Current liabilities 60 100 140 180 220 Long-term liabilities 120 120 120 120 120 Owners' equity 210 220 230 240 250 Total 390 440 490 540 590

Answer 1

Debt ratio will remain same in both the scenario 1 and 2. So total outside liabilities (whether short term or long term) does not affect the risk of the enterprise.

C) In scenario 1, current ratio is declining as more and more funds that are required in the enterprise are funded using short term bank notes and is therefore risky as there may arise a situation where funds won't be available for carrying out day to day operations of the enterprise..

So for long term uses of funds, enterprise should prefer using long term findings instead of short term bank notes leading to the less risky option for the enterprise.

Enterprise may make a trade off between long term and short term borrowings in such a way that the sufficient funds are available for carrying out the business of the enterprise and most viable portfolio option is created.

Financial plan 1 is more risky.

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