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Cornerstones of Financial Accounti...

4th Edition
Jay Rich + 1 other
ISBN: 9781337690881

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Cornerstones of Financial Accounti...

4th Edition
Jay Rich + 1 other
ISBN: 9781337690881
Textbook Problem
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Short-Term Borrowing with Restrictions

Rocky Mountain Products has a line-of-credit agreement with Norwest Bank that allows it to borrow up to $100,000 at any given time provided that Rocky Mountain’s current assets always exceed its current liabilities by the principal amount of the outstanding loan. If this requirement is violated, the entire loan is payable immediately; thus Rocky Mountain is very careful to fulfill the requirement at all times. All loans under this line of credit are due in 1 month and bear interest at a rate of 1% per month. On January 1, 2019, Rocky Mountain has current assets of $150,000 and current liabilities of $92,000; hence, the excess of current assets over current liabilities is $58,000. Rocky Mountain’s current liabilities at January 1, 2019, include a short-term loan under the line of credit of $35,000 due on February 1, 2019.

Required:

Without violating the loan restriction, how much more could Rocky Mountain borrow under its line of credit on January 1, 2019, to invest in inventory? To invest in new equipment? Explain.

To determine

Concept introduction:

Current Ratio:

Current Ratio is measure of the company’s ability to pay off its current liabilities using its current assets. It is calculated by dividing the total current assets by total current liabilities. The formula of the current ratio is as follows:

Current Ratio=Current assetsCurrent liabilities

To calculate:

The maximum amount of additional borrowing for inventory and for new equipment.

Explanation

The borrowing for inventory shall result in equal increase in current assets and liabilities so the company can borrow the maximum amount of loan that is $100,000...

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