Question

The Nelson Company has $1,667,500 in current assets and $575,000 in current liabilities. Its initial inventory level is $402,500, 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.

Answer 1

Nelson's short-term debt (notes payable) can increase to $920,000 without pushing its current ratio below 1.3

Let “X” Taken as additional notes payables used to increase inventory.

Current Ratio = Current Assets / Current Liabilities

1.30 = [ $16,67,500 + X ] / 575,000

$747,500 = $16,67,500 + X

X = $920,000

Short-term debt can increase by a maximum of $920,000 without violating a 1.3 : 1 current ratio, assuming that the entire increase in notes payable is used to increase current assets.

Because we assumed that the additional funds would be used to increase inventory, the inventory account will increase to $13,22,500 = $402,500 + 920,000, and current assets will total $25,87,500 [ $16,67,500 + 920,000 ]

Calculation of Quick-Ratio

Revised Current Assets = $25,87,500

Revised Inventory Value = $13,22,500

Revised Current Liabilities = $575,000 + 920,000 = $14,95,000

Therefore, Quick Ratio = [ Total Current Assets – Inventories ] / Total Current Liabilities

= [$25,87,500 - $13,22,500 ] / $14,95,000

= $1265000 / 1495000

= 0.85

" QUICK-RATIO is 0.85 "