Question

2015 PHILIPPE CORPORATION 2014 and 2015 Balance Sheets ($ in millions) 2014 Assets Current assets Cash $ 210 Accounts receivable Inventory 507 Total $1,072 Fixed assets Net plant and equipment $6,085 Total assets $7,157 355 $ 215 310 328 $ 853 $6,527 $7,380 $ 298 1,427 Liabilities and Owners' Equity Current liabilities Accounts payable $ 207 Notes payable 1,715 Total $1,922 Long-term debt $1,987 Owners' equity Common stock and paid-in surplus $1,000 Retained earnings 2,248 Total $3,246 Total liabilities and owners' equity $7,157 $1,725 $2,308 $1,000 2,347 $3,347 $7,380

Question: What effect would the following actions have on Philippe Corporation’s current ratio? Provide your reasoning.

a. Starting 2015 Current Ratio = _________________

b. $100 Inventory is purchased with cash.

c. A supplier is paid $100 with cash.

d. A short-term bank loan of $100 is repaid with cash.

e. A long-term debt of $100 is paid off early.

f. A customer pays off a credit account of $100.

g. Inventory is sold for $100 at cost.

h. Inventory is sold for $200 - a profit of $100.

Answer 1

a)

Current ratio = Current assets/Current liabilities

= 853/1,725

= 0.49

b. $100 Inventory is purchased with cash.

Current assets would increase by $100 in the form of inventory and decrease by $100 in the form of cash. Current ratio will not change since both the current assets and current liabilities will remain same as before.

Current ratio = (853 + 100 - 100)/1,725

= 853/1,725

= 0.49

c. A supplier is paid $100 with cash.

Current ratio will decrease since both the current assets and current liabilities will decrease by the same amount.

Current ratio = (853 - 100)/(1,725 - 100)

= 753/1,625

= 0.46

d. A short-term bank loan of $100 is repaid with cash.

Current ratio will decrease since both the current assets and current liabilities will decrease by the same amount.

Current ratio = (853 - 100)/(1,725 - 100)

= 753/1,625

= 0.46

e. A long-term debt of $100 is paid off early.

Current ratio will decrease since only current assets will decrease and current liabilities will remain same as before.

Current ratio = (853 - 100)/1,725

= 753/1,725

= 0.44

f. A customer pays off a credit account of $100.

Current assets would increase by $100 in the form of cash and decrease by $100 in the form of accounts receivable. Current ratio will not change since both the current assets and current liabilities will remain same as before.

Current ratio = (853 + 100 - 100)/1,725

= 853/1,725

= 0.49

g. Inventory is sold for $100 at cost.

Current assets would increase by $100 in the form of cash and decrease by $100 in the form of inventory. Current ratio will not change since both the current assets and current liabilities will remain same as before.

Current ratio = (853 + 100 - 100)/1,725

= 853/1,725

= 0.49

h. Inventory is sold for $200 - a profit of $100.

Current assets would increase by $200 in the form of cash and decrease by $100 in the form of inventory.Current ratio will increase since only current assets will increase and current liabilities will remain same as before.

Current ratio = (853 + 200 - 100)/1,725

= 953/1,725

= 0.55

Please ask if you have any query related to the question. Thank you