Question

Current and Quick Ratios The Nelson Company has $1,820,000 in current assets and $700,000 in current liabilities. Its initial inventory level is $350,000, 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 1.7? 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

Current ratio is calculated by dividing the current assets by current liabilities. Current ratio is used to calculate the liquidity of the company
Let the additional notes payable required be x.
Calculation of additional notes payable
Current ratio = Current assets + X/Current liabilities + X
1.7 = (1820000+X)/(700000+X)
1.7*(700000+X) = 1820000+X					1190000
1190000+1.7X = 1820000+X
1.7X - X = 1820000-1190000
0.7X = 630000				630000
X = 630000/0.7
X	900000
The maximum short term debt can increase by $900,000 without impacting the current ratio of 1.7
Quick ratio = Current assets - Inventories/Current Liabilities
Quick ratio = (1820000-350000)/(700000+900000)
Quick ratio	0.92
The quick ratio after raising short term funds is 0.92