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Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

CURRENT RATIO The Stewart Company has $2,392,500 in current assets and $1,076,625 in current liabilities. Its initial inventory level is $526,350, 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:

The current ratio is a part of liquidity ratio, which reflects the capability of the company to pay back its short-term debts. It is calculated based on the current assets and current liabilities that a company posses in an accounting period.

Current Assets:

The assets of the company, which needs to be converted into cash in less than a 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 the current accounting period is called current liabilities.

Explanation

Given,

Current asset is $2,918,850 (working note).

Current liabilities are $1,076,625.

Formula to calculate minimum current ratio is,

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

Substitute 2 times for minimum current ratio, $2,918,850 for current assets and $1,076,625 for current liabilities.

2 times=$2,918,850+Notes Payable$1,076,625+Notes Payable$2,153,250+2 Notes Payable=$2,918,850+Notes Payable2Notes PayableNotes Payable=$2,918,850$2,153,250Notes Payable=$765,600

Thus, the short-term debt is increased by $765,600

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