Question

The Nelson Company has $1,750,000 in current assets and $700,000 in current liabilities. Its initial inventory level is $490,000, 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 1.9? Round your answer to the nearest cent. $ 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.

Answer 1

Answer:

(a) Short-term debt can increase by a maximum of $466,666.67 without pushing its current ratio below 1.9

(b) The firm's quick ratio after Nelson has raised the maximum amount of short-term funds is 1.34

Explanation:

Current assets = $1,750,000

Current liabilities = $700,000

Initial inventory level = $490,000

Current ratio = Current assets ÷ Current liabilities

= $1,750,000 ÷ $700,000 = 2.5

1.9 = (Current assets + $\Delta{NP$) ÷ (Current liabilities + $\Delta{NP$)

1.9 = ($1,750,000 + $\Delta{NP$) ÷ ($700,000 + $\Delta{NP$)

1.9 × ($700,000 + $\Delta{NP$) = ($1,750,000 + $\Delta{NP$)

$1,330,000 + $1.9\Delta{NP$ = $1,750,000 + $\Delta{NP$

$0.9\Delta{NP$ =  $1,750,000 - $1,330,000

$\Delta{NP$ = $466,666.67

Short-term debt can increase by a maximum of $466,666.67 without pushing its current ratio below 1.9

Quick ratio = (Current assets - Inventories) ÷ Current liabilities

= $937,500 ÷ $700,000

= 1.34