Question

The Nelson Company has $1,312,500 in current assets and $525,000 in current liabilities. Its initial inventory level is $375,000, 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 2.0? What will be the firm’s quick ratio after Nelson has raised the maximum amount of short-term funds? Ehrhardt, Michael C.. Corporate Finance: A Focused Approach (MindTap Course List) (p. 130). Cengage Learning. Kindle Edition.

Answer 1

Answer:

Explanation:

Current ratio = Current assets/current liabilities

Quick ratio = Current assets-Inventories/current liabilities

Current ratio = 1,312,500/525,000 = 2.5

If the firm wants to raise funds as additional note payable without icreasing its current ratio of 2:

Current ratio = (Current assets+NP)/(Current liab.+NP)

2 = (1,312,500+NP)/(525,000+NP)

NP = 262,500; Additinal Note payable can be maximum of 262,500

Quick ratio = (1,312,500-(375,000+262,500))/787,500 = 1.19