Question

The Nelson Company has $1,150,000 in current assets and $460,000 in current liabilities. Its initial inventory level is $300,000, 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 2.2? 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

Given,

Current assets = $1150000

Current liabilities = $460000

Inventory = $300000

Minimum current ratio = 2.2

Solution :-

Minimum current ratio

= (Current assets + increase in notes payable)/(current liabilities + increase in notes payable)

2.2 = ($1150000 + increase in notes payable)/($460000 + increase in notes payable)

2.2 x ($460000 + increase in notes payable) = $1150000 + increase in notes payable

$1012000 + (2.2)increase in notes payable = $1150000 + increase in notes payable

(2.2)increase in notes payable - increase in notes payable = $1150000 - $1012000

(1.2)increase in notes payable = $138000

Increase in notes payable = $138000/1.2 = $115000

So,

Short term debt can increase by maximum of $115000 without pushing its current ratio below 2.2

Increase in inventory = increase in notes payable = $115000

New inventory = $300000 + $115000 = $415000

New current assets = current assets + increase in inventory

= $1150000 + $115000 = $1265000

New current liabilities = current liabilities + increase in notes payable

= $460000 + $115000 = $575000

Now,

Quick ratio = (new current assets - new inventory)/new current liabilities

= ($1265000 - $415000)/$575000

= $850000/$575000 = 1.48 times