The Nelson Company has $1,147,500 in current assets and $425,000 in current liab

Question

The Nelson Company has $1,147,500 in current assets and $425,000 in current liabilities. Its initial inventory level is $340,000, 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 1.6? 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

Nelson current ratio now is $1,147,500/$425,000= 2.7 . You could increase notes payable by $780,000 which would provide a corresponding increase in inventory. This would move the ratio to $1,927,500/$1,205,000=1.6 .

This figure is calculated by the foloowing equation:

1.6 = (1,147,500 + x )/ (425,000 + x)

The quick ratio after borrowing $780,000 and purchasing inventory would be ($1,927,500-1,120,000)/$1,205,000= 0.67 . The $1,120,000 is calculated as beginning inventory of $340,000 plus the additional inventory purchased of $780,000

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