Final answer:
Nelson's short-term debt can increase by up to $116,250 without the current ratio falling below 2.0. After this increase, the firm's quick ratio will be 1.54.
Step-by-step explanation:
To calculate how much Nelson's short-term debt (notes payable) can increase without pushing its current ratio below 2.0, we use the formula for the current ratio:
Current Ratio = Current Assets / Current Liabilities
We are given that Nelson Company has:
- Current Assets = $1,162,500
- Current Liabilities = $465,000
- Initial Inventory Level = $330,000
The current ratio must stay at 2.0 or above, which means:
Current Assets / (Current Liabilities + Additional Notes Payable) ≥ 2.0
Substituting the given values and solving for the maximum allowable increase in notes payable:
$1,162,500 / ($465,000 + Additional Notes Payable) = 2.0
$1,162,500 = 2.0 * ($465,000 + Additional Notes Payable)
$1,162,500 = $930,000 + 2.0 * Additional Notes Payable
Additional Notes Payable = ($1,162,500 - $930,000) / 2.0
Additional Notes Payable = $232,500 / 2.0
Additional Notes Payable = $116,250
Thus, Nelson's short-term debt can increase by up to $116,250 without the current ratio falling below 2.0.
Next, the quick ratio can be calculated as follows:
Quick Ratio = (Current Assets - Inventory) / Current Liabilities
After the additional notes payable, the new inventory value will be:
New Inventory Value = Initial Inventory Level + Additional Notes Payable
New Inventory Value = $330,000 + $116,250
New Inventory Value = $446,250
Now, calculating the quick ratio:
Quick Ratio = ($1,162,500 - $446,250) / $465,000
Quick Ratio = $716,250 / $465,000
Quick Ratio = 1.54
The firm's quick ratio after the additional notes payable will be 1.54.