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26 April, 12:26

Current and Quick Ratios The Nelson Company has $1,250,000 in current assets and $500,000 in current liabilities. Its initial inventory level is $400,000, 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 1.2

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  1. 26 April, 12:28
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    Nelson's short-term debt (notes payable) can increase by $541,667 without pushing its current ratio below 1.2.

    Explanation:

    We know that the formula for calculating the current ratio is as follows:

    Current ratio = Current Assets / Current Liabilities ... (1)

    Where;

    Existing Current assets = $1,250,000

    Existing current liabilities = $500,000

    Existing Current ratio = $1,250,000 / $500,000 = 2.50

    Since we want to keep the current assets at $1,250,000, and targeted current ratio is 1.2; we want to determine the following:

    Targeted current liabilities = ?

    We therefore also use and substitute into equation (1) as follows:

    Targeted current ratio = Existing Current assets / Targeted current liabilities

    Therefore, we have:

    1.2 = $1,250,000 / Targeted current liabilities

    Solving for Targeted current liabilities, we have:

    Targeted current liabilities = $1,250,000 / 1.2 = $1,041,667

    Therefore, we have:

    Targeted increase in short-term debt = Targeted current liabilities - Existing current liabilities = $1,041,667 - $500,000 = $541,667

    Therefore, Nelson's short-term debt (notes payable) can increase by $541,667 without pushing its current ratio below 1.2.
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