Pepsi Corporation\'s current ratio is 1.25, while Coke Company\'s current ratio

Question

Pepsi Corporation's current ratio is 1.25, while Coke Company's current ratio is 0.75. Both firms will attempt to "window dress" their coming end-of-year financial statements. As part of their window dressing strategy, Pepsi will triple its current liabilities by adding short-term debt and placing the funds obtained in the cash account. Coke will double its total liabilities by adding long-term debt and placing the funds obtained in the cash account. Which of the statements below best describes the actual results of these transactions?

Only Pepsi‘s current ratio will be decreased
       Both current ratios of both firms will be decreased
       Both current ratios of both firms will be increased
       Only Pepsi’s current ratio will be increased
       The transactions will have no effect on both current ratios

Explanation / Answer

CURRENT RATIO (PEPSI) = CURRENT ASSETS/CURRENT LIABILITIES = 1.25 = 125/100 (ASSUMED)

NOW CURRENT LIABILITIES WILL BE TRIPLED = 100 X 3 = 300 (THAT IS TAKE SHORT TERM DEBT OF 200) BUT THIS AMOUNT WILL BE PLACED IN CASH, SO TOTAL CURRENT ASSETS WILL ALSO INCREASE BY 200, SO TOTAL CURRENT ASSETS = 125 + 200 = 325

SO CURRENT RATIO (PEPSI) = 325/300 = 1.083 SO CURRENT RATIO HAS DECREASED

CURRENT RATIO OF COKE IS 0.75

NOW IF COMPANY ISSUES LONG TERM DEBT, THE CURRENT LIABILITIES WILL NOT CHANGE, AND AS FUNDS ARE PLACED IN CASH ACCOUNT, CURRENT ASSETS WILL INCREASE

SO CURRENT LIABILITIES ARE SAME & CURRENT ASSETS HAS INCREASED, SO CURRENT RATIO OF COKE WILL INCREASE.

SO ANSWER IS : ONLY PEPSI'S CURRENT RATIO WILL DECREASE

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