Question

Current and Quick Ratios

The Nelson Company has $1,322,500 in current assets and $575,000 in current liabilities. Its initial inventory level is $287,500, and it will raise funds as additional notes payable and use them to increase inventory.

1. How much can Nelson's short-term debt (notes payable) increase without pushing its current ratio below 1.4? Round your answer to the nearest cent.

   $  

2. 
   
3. 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 = Current assets / current liabilities

Here company want issue short term debt and purchase a inventory without pushing the ratio below to  1.4

1.4 = (current assets + Notes payable ) / (current liabilities + Notes payable )

1.4 = ($ 1,322,500 + Notes payable) / ($ 575,000 + Notes payable)

$ 805,000 + 1.4 Notes payable = $ 1,322,500 + Notes payable

0.4  Notes payable = $ 517,500

Notes payable = $ 1,293,750

How much can Nelson's short-term debt (notes payable) increase is $ 1,293,750

If Short term issue and use to purchase inventory then current assets & liabilities are

Current assets = $1,322,500 + $ 1,293,750 = $ 2,616,250

Inventory =  $287,500 + $ 1,293,750 = $ 1,581,250

Current liabilities = $ 575,000 + $ 1,293,750 = $ 1,868,750

Current ratio = current assets / current liabilities = $ 2,616,250 / $ 1,868,750 = 1.4 times

Quick ratio = (current assets - inventory ) / current liabilities = ($ 2,616,250 - 1,581,250) / $ 1,868,750 = 0.55385 times