Question

The Nelson Company has $1,212,500 in current assets and $485,000 in current liabilities. Its initial inventory level is $315,000, 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? Do not round intermediate calculations. Round your answer to the nearest dollar.

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What will be the firm's quick ratio after Nelson has raised the maximum amount of short-term funds? Do not round intermediate calculations. Round your answer to two decimal places.

Answer 1

Before increase in inventory:

Current Assets = $1,212,500
Current Liabilities = $485,000

Let increase in inventory and short-term debt be $x

After increase in inventory:

Current Assets = $1,212,500 + $x
Current Liabilities = $485,000 + $x

Current Ratio = Current Assets / Current Liabilities
2.00 = ($1,212,500 + $x) / ($485,000 + $x)
$970,000 + 2 * $x = $1,212,500 + $x
$x = $242,500

Increase in Inventory = $242,500

Current Assets = $1,212,500 + $242,500
Current Assets = $1,455,000

Inventory = $315,000 + $242,500
Inventory = $557,500

Current Liabilities = $485,000 + $242,500
Current Liabilities = $727,500

Quick Ratio = (Current Assets - Inventory) / Current Liabilities
Quick Ratio = ($1,455,000 - $557,500) / $727,500
Quick Ratio = 1.23