Question

GreenChapeau, Inc. is planning to increase its short-term loans (i.e., increase notes payable) to pay for an increase in the firm’s basic inventory level (i.e., increase inventory). GreenChapeau believes that this event will have no affect on either sales or costs, and therefore no affect on net income.

All else constant, this new policy should cause the firm’s current ratio (assuming a current ratio of 1.5) to:

1. Increase

2. Decrease

3. No Change

4. Not enough information is provided to answer this question.

Answer 1

Answer : Decrease (Thumbs up please)

explanation :

if current ratio = 1.5, we can assume that current assets are 1.5 times current liabilities.

if we further assume that current liabilities are 100000 then current assets will be 1.5 time current liabilities = 150000

Now if notes payable is increased say by 25000, then current liabilities will increase by 25000

and as notes payable is used in building inventories, current assets will also increase by 25000

S0 current assets will be = 175000, current liabilities will be = 125000

and current ratio will be = 175000/125000 = 1.4

so result is decrease in current ratio.