Current and Quick Ratios The Nelson Company has $900,000 in current assets and $

Question

Current and Quick Ratios The Nelson Company has $900,000 in current assets and $450,000 in current liabilities. Its initial inventory level is $360,000, 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 1.2? Round your answer to the nearest cent. 300,000 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 0.32 I *

Explanation / Answer

1. CURRENT RATIO = CA/CL

CURRENT ASSETS= $9,00,000/4,50,000 = 2

THE CURRENT RTAIO AT PRESENT IS 2,

TO ENSURE IT DOES NOT FALL BELOW 1.2 , THE MAXIMUM SHORT TERM DEBT THE FIRM CAN RAISE IS :

LET THE LEVEL OF INVENTORY INCREASE AND THE NOTES PAYABLE BE X

9,00,000+ X/4,50,000+ X = 1.2

OR, 9,00,000+X = 540000 + 1.2X

3,60,000 = 0.2X

X= 18,00,000

THE SHORT TERM DEBT CAN INCREASE BY MAXIMUM 18,00,000.

2.THE QUICK RATIO DOES NOT TAKE INTO ACCOUNT INVENTORY, BECAUSE INVENTORY CANNOT BE EASILY CONVERTED INTO CASH,

SO, THE QUICK RATIO IS : QUICK ASSETS/ CURRENT LIABILITIES:

CA- INVENTORY : 5,40,000

CURRENT LIABILITIES = 4,50,000 + 18,00,000

540000/ 2250000= 0.24

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