Question

Current and Quick Ratios The Nelson Company has $1,105,000 in current assets and $425,000 in current liabilities. Its initial inventory level is $212,500, 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 1.6? 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. Help, please!

Answer 1

Before increase in inventory by borrowing short-term debt:

Current assets = $1,105,000
Current liabilities = $425,000
Inventory = $212,500

Let increase in inventory be $x

After increase in inventory by borrowing short-term debt:

Current assets = $1,105,000 + $x
Current liabilities = $425,000 + $x
Inventory = $212,500 + $x

Current ratio = Current assets / Current liabilities
1.60 = ($1,105,000 + $x) / ($425,000 + $x)
$680,000 + 1.60 * $x = $1,105,000 + $x
0.60 * $x = $425,000
$x = $708,333.33

Nelson can borrow upto $708,333.33 without pushing its current ratio below 1.60.

After increase in inventory by borrowing short-term debt:

Current assets = $1,105,000 + $708,333.33
Current assets = $1,813,333.33

Current liabilities = $425,000 + $708,333.33
Current liabilities = $1,133,333.33

Inventory = $212,500 + $708,333.33
Inventory = $920,833.33

Quick ratio = (Current assets - Inventory) / Current liabilities
Quick ratio = ($1,813,333.33 - $920,833.33) / $1,133,333.33
Quick ratio = 0.79