Current and Quick Ratios 1.a The Nelson Company has $1,140,000 in current assets

Question

Current and Quick Ratios

1.a

The Nelson Company has $1,140,000 in current assets and $475,000 in current liabilities. Its initial inventory level is $285,000, and it will raise funds as additional notes payable and use them to increase inventory.

1b.How much can Nelson's short-term debt (notes payable) increase without pushing its current ratio below 2.1? 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.

Explanation / Answer

Current Assets (CA) = $1,140,000
Current Liabilities (CL) = $475,000

a)Thus the present current ratio is Current Ratio = CA/CL = 1,140,000/475,000 = 2.4

Thus if funds are raised using notes payable (short term debt) both the current assets (cash) as well as the current liabilities (paybles) will increase by the same amount (say x).

Thus we have to find x, such that:

(1,140,000+x)/(475,000+x)=2.1

Solving for X we have the increase in short term debt:

X= 129,416.89 $.
Anything above this X will drop the current ratio below 2.1

b)Quick ratio = (current assets – inventories) / current liabilities
Thus new CA = 1,140,000+x = 1,269,416.89$
new CL = 475,000+x = 604,416.8$
Inventory (given in question) = 285,000$

Thus putting the new values of CA & CL which we computed after increasing the short term debt. We have
Quick Ratio = (1,269,416.89-285,000)/604,416.8= 1.628

New quick ratio =

(1,140,000+x)/(475,000+x)=2.1

Solving for X we have the increase in short term debt:

X= 129,416.89 $.
Anything above this X will drop the current ratio below 2.1

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