The Nelson Company has $1,312,500 in current assets and $525,000 in current liab

Question

The Nelson Company has $1,312,500 in current assets and $525,000 in current liabilities.  Its initial inventory level is $375,000, and it will raise funds as additional notes payable and use them to increase inventory. How much can Nelson

The Nelson Company has $1,312,500 in current assets and $525,000 in current liabilities. Its initial inventory level is $375,000, 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 2.0? What will be the firm's quick ratio after Nelson has raised the maximum amount of short-term funds?

Explanation / Answer

Your current ratio now is $1,312,500/$525,000= 2,5,

You could increase notes payable by $262,500 which would provide a corresponding increase in inventory. This would move the ratio to $1,575,000/$787,500=2. The quick ratio after borrowing $262,500 and purchasing inventory would be ($1,575,000-637,500)/$787,500=1.19.

The $637,500 is calculated as beginning inventory of $375k plus the additional inventory purchased of $262,500.

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