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Show the effect of the following transactions on cash, net working capital, and the current ratio. Assume that the current ratio exceeds 1.0 to begin. The firm borrows $1,000 short-term and pays $500 in accounts payable. The firm factors $1,000 in receivables at a 5% discount. The firm issues $1,000 in long-term bonds, using the proceeds to pay $800 in payables and purchase $200 in marketable securities.

User Letholdrus
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Final answer:

Borrowing short-term and paying accounts payable increases cash and keeps net working capital unchanged. Factoring receivables decreases net working capital. Issuing long-term bonds and managing payables and securities increases net working capital and the current ratio.

Step-by-step explanation:

To understand the effect of various transactions on cash, net working capital, and the current ratio for a firm, let's examine each transaction individually. Cash is a component of current assets, net working capital is the difference between current assets and current liabilities, and the current ratio is the proportion of current assets to current liabilities.

Transaction 1: Borrowing $1,000 short-term and paying $500 in accounts payable increases cash by $1,000 but also increases current liabilities by $1,000. Paying $500 in accounts payable decreases current liabilities by $500. The net effect on cash is an increase of $500, net working capital remains unchanged, and the current ratio may either increase or stay the same.

Transaction 2: Factoring $1,000 in receivables at a 5% discount converts receivables to cash, which after discount gives $950 in cash. Current assets decrease by $1,000, and cash increases by $950, leading to a $50 loss. This decreases net working capital and may decrease the current ratio.

Transaction 3: Issuing $1,000 in long-term bonds increases cash without affecting current liabilities. Paying $800 in payables decreases current liabilities and increases net working capital. Purchasing $200 in marketable securities increases current assets. Overall, cash increases, net working capital increases, and the current ratio improves.

User Alex Tonkonozhenko
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