Ask Question
17 March, 17:48

The Nelson Company has $1,875,000 in current assets and $625,000 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.

(a) How much can Nelson's short-term debt (notes payable) increase without pushing its current ratio below 1.2?

(b) What will be the firm's quick ratio after Nelson has raised the maximum amount of short-term funds?

+3
Answers (1)
  1. 17 March, 17:56
    0
    A) Short-term debt increase = 5,625,000

    B) Quick Ratio = 0.24

    Explanation:

    a) Current Ratio = Current Asset (CA) / Current Liabilities (CL)

    Acording to the current ratio formula, to calculate the amount of short-term debt increase, to the amount of current assets and current liabilities we must add an amount such that the result is 1.2.

    (1,875,000 + x) / (625,000 + x) = 1.2

    (1,875,000 + x) = 1.2 * (625,000 + x)

    1,875,000 + x = (1.2 * 625,000) + (1.2 x)

    1,875,000 + x = 750,000 + 1.2 x

    1,875,000 - 750,000 = 1.2 x - x

    1,125,000 = 0.2 x

    1,125,000 / 0.2 = x

    x = 5,625,000

    So the maximum that should be borrowed to buy inventory is 5,625,000

    b) Quick Ratio = (Current Asset (CA) - Inventory (I) - Prepaid Expenses (PE)) / Current Liabilities (CL)

    For the Current Asset, the taken is 1,500,000 (1,875,000 - 375,000) because we don't include the original inventory and the maximum increase. For the current liabilities, we take 6,250,000 (625,000 + 5,625,000) that is the original amount add to the maximum increase

    Quick Ratio = 1,500,000 / 6,250,000

    Quick Ratio = 0.24
Know the Answer?
Not Sure About the Answer?
Find an answer to your question 👍 “The Nelson Company has $1,875,000 in current assets and $625,000 in current liabilities. Its initial inventory level is $375,000, and it ...” in 📗 Business if the answers seem to be not correct or there’s no answer. Try a smart search to find answers to similar questions.
Search for Other Answers