Question

11. Problem 4.19 Click here to read the eBook: Liquidity Ratios CURRENT RATIO The Stewart Company has $1,506,000 in current assets and $632,520 in current liabilities. Its initial inventory level is $346,380, and it will raise funds as additional notes payable and use them to increase inventory. How much can its short-term debt (notes payable) increase without pushing its current ratio below 2.0? Round your answer to the nearest cent.

Answer 1

Current Ratio = Total Current Assets / Total Current Liabilities Let 'p' be the quantum of increase in inventory and supporting short-term note payable. It is given that the current ratio must not go below 2.0. So, the current ratio should be equal to 2.0 at least. 2.0 = (Initial current assets + p) / (Initial current liabilities + p) 2.0 = ($1,506,000 + p)/($632,520 + p) ($632,520 + p) x 2.0 = ($1,506,000 + p) $1,265,040 + 2p = $1,506,000 + p 2p - p = $1,506,000 - $1,265,040 p = $240,960 Therefore, short-term note payable can increase by $240960 without pushing its current ratio below 2.0.