Assume that the current ratio for Arch Company is 3.5, its acid-test ratio is 2.

Question

Assume that the current ratio for Arch Company is 3.5, its acid-test ratio is 2.0, and its working capital is $330,000. Answer each of the following questions independently, always referring to the original information. Required: a. How much does the firm have in current liabilities? . If the only current assets shown on the balance sheet for Arch Company are Cash, Accounts Receivable, and Merchandise Inventory, how much does the firm have in Merchandise Inventory? (Do not round intermediate calculations.) If the firm collects an account receivable of $106,000, what will its new current ratio and working capital be? ( d. If the firm pays an account payable of $60,000, what will its new current ratio and working capital be? d. If the firm pays an account payable of $60,000, what will its new current ratio and working capital be?

Explanation / Answer

Current ratio = Current Assets / Current Liabilities = 3.5

Quick Ratio / Acid test Ratio = Quick Assets / Current Liabilities = 2.0

Working Capital = Current Assets - Current Liabilities = 330,000

(a) CR = 3.5

Let us assume CL = x, then CA = 3.5x

So, working capital = 3.5x - x = 2.5x and WC is given as 330,000

Equating the two, we get 2.5x = 330,000, x = 330,000 / 2.5 = 132,000

So , current liablities = $132,000

(b) From the above calculation, if CL = 132,000, then CA = 3.5x = 3.5 * 132,000 = 462,000

     and quick assets = 2 * 132,000 = 264,000

    So, mercahndise inventory = Current assets - Quick Assets = 462,000 - 264,000 = 198,000

(c) If firm collects an accounts receivable of $106,000, then its current assets will not be affected by this amount as one current asset (cash) will increase and the other current asset (accounts receivable) will decrease. So, the net effect will be zero. Hence, working capital and current ratio will remain the same.

(d) If the firm pays an accounts payable of $60,000, it will reduce current liabilities (accounts payable) as well as current asset (cash). So, new current asset = 462,000 - 60,000 = 402,000 and new current liability = 132,000 - 60,000 = 72,000

New WC = 402,000 - 72,000 = 330,000 ie it remains the same

New CR = 402,000 / 72,000 = 5.58 ie it increases

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