The Nelson Company has $1,050,000 in current assets and $500,000 in current liab

Question

The Nelson Company has $1,050,000 in current assets and $500,000 in current liabilities. Its initial inventory level is $350,000, 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 1.8? Round your answer to the nearest cent.

2.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

Answer to Part 1

Current Assets = $ 1,050,000

Current Liabilities= $ 500,000

Current Ratio = Current Assets / Current Liabilites = 1,050,000 / 500,000

Current Ratio = 2.1

Let the amount that can be added to Inventory by raising Nots payable be "x"

New Current Ratio = 1.8

1.8 = (1,050,000 + x) / (500,000 + x)

1.8 (500,000 + x) = (1,050,000 + x)

900,000 + 1.8x = 1,050,000 + x

0.8x = 150,000

x = 187,500

The amount which can be additionally raised through Short term debt (notes payable) is $ 187,500

Answer to Part 2.

Quick Ratio = (Current Assets Inventory) / Current Liabilites

New Inventory level= 350,000 + 187,500 = $ 537,500

Quick Ratio = (1,050,000 - 537,500) / 500,000

Quick Ratio = 512,500/ 500,000

Quick Ratio = 1.03

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