Question

Lofland's has $20 million in current assets and $10 million in current liabilities, while Smaland's current assets are $10 million versus $20 million of current liabilities. Both firms would like to "window dress" their end-of-year financial statements, and to do so each plans to borrow $10 million on a short-term basis and to then hold the borrowed funds in their cash accounts. Which of the statements below best describes the results of these transactions?a.The transaction would improve both firms' financial strength as measured by their current ratios.b.The transactions would raise Lofland's financial strength as measured by its current ratio but lower Smaland's current ratio.c.The transactions would lower Lofland's financial strength as measured by its current ratio but raise Smaland's current ratio.d.The transaction would have no effect on the firm' financial strength as measured by their current ratios.e.The transaction would lower both firm' financial strength as measured by their current ratios

Answer 1

Answer:

c.The transactions would lower Lofland's financial strength as measured by its current ratio but raise Smaland's current ratio.

Explanation:

The current ratio compares current assets with current liabilities showing how many dollars of assets are there for a dollar of liabilities. This tells investors about the company ability to pay short-term obligations or those due within one year.

Current Ratio = Current Asset (CA) / Current Liabilities (CL)

Lofland's NOW = 20 M CA / 10 M CL = 2.00

Lofland's AFTER = 30 M CA / 20 M CL = 1.50

Smaland's NOW = 10 M CA / 20 M CL = 0.50

Smaland's AFTER = 20 M CA / 30 M CL = 0.67

Lofland's current ratio gets lower, so its financial strength as well. Instead, Smaland's current ratio gets higher and It´s financially stronger.