Mukhopadhya Network Associates has a current ratio of 1.60, where the current ra

Question

Mukhopadhya Network Associates has a current ratio of 1.60, where the current ratio is defined as follows: current ratio = current assets/current liabilities. The firm's current assets are equal to $1,233,265, its accounts payables are $419,357, and its notes payables are $351,663. Its inventory is currently at $721,599. The company plans to raise funds in the short-term debt market and invest the entire amount in additional inventory. How much can notes payable increase without the current ratio falling below 1.50?

Explanation / Answer

First of all, be aware that the current ratio is Current Assets/Current Liabilities. In this case, the current ratio is CR = 1,233,265/(419,357+351,663) = 1,233,265/771,020 = 1.6 You are going to borrow money to buy inventory, so you are going to increase the denominator of the equation above by X. The maximum you can borrow is the X that gives you 1.44 current ratio. So, the formula is: 1.44 = 1,233,265/(771,020 + X) 1.44 (771,020 + X) = 1,233,265 1,110,268.8 + 1.44X = 1,233,265 X = (1,233,265 - 1,110,268.8)/1.44 = 85,414.03 The company can borrow up to $85,414 and maintain its current ratio below 1.44

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