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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

CURRENT RATIO The Petry Company has $1312,500 in current assets and $525,000 in current liabilities. Its initial inventory level is $375,000, 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?

Summary Introduction

To identify: The increase in short-term debt without pushing its current ratio below 2.

Current Ratio:

Current ratio is a part of liquidity ratio, which reflects the capability of the company to payback its short term debts. It is calculated based on the current assets and current liabilities that a company possess in an accounting period.

Current Assets:

The assets of the company which need to be converted into cash in less than one year or during current accounting period are called current assets.

Current Liabilities:

The debts or liabilities that need be paid in less than one year or during current accounting period is called current liabilities.

Explanation

Solution:

Given,

Current asset is $1,687,500 (working note).

Current liabilities are $526,350.

Formula to calculate minimum current ratio is,

Minimum Current Ratio=Current Assets+Notes PayableCurrent Liabilities+Notes Payable

Substitute 2 times for minimum current ratio, $1,687,500 for current assets and $526,350 for current liabilities.

2 times=$1,687,500+Notes Payable$526,350+Notes Payable$1,052,700+2 Notes Payable=$1,687,500+Notes Payable2Notes PayableNotes Payable=$1,687,500$1,052,700Notes Payable=$634,800

Thus, the short-term debt is increased by $634,800.

Working notes:

Current asset is $1,312,500

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