Question

Baker Corp. is required by a debt agreement to maintain a current ratio of at least 2.5, and Baker's current ratio now is 3. Baker wants to purchase additional inventory for its upcoming Christmas season, and will pay for the inventory with short-term debt. How much inventory can Baker purchase without violating its debt agreement if their total current assets equal exist15 million?
A. exist0.50 million
B. exist1.67 million
C. exist4.50 million
D. exist6.00 million

Answer 1

Answer:

The maximum that should be expand short time debts  and inventories is $ 1,666,667.

Explanation:

First the amount of current liabilities must be known:

Current Ratio = Current Asset / Current Liabilities  

3 = 15,000,000 / X  

X = 15,000,000 / 3

X= 5,000,000

To know how much to expand short time debts  and inventories in the formula of the current ratio, to the amount of current assets and current liabilities must add an amount such that the result is 2.5.  

(15,000,000 + x) / (5,000,000 + x) = 2.5

(15,000,000 + x) = 2.5 * (5,000,000 + x)

 15,000,000 + x = (2.5 * 5,000,000) + (2.5 x)

 15,000,000 + x = 12,500,000 + 2.5 x

 15,000,000 - 12,500,000 = 2.5 x – x

  2,500,000 / 1.5  = x

  1,666,667 = x

 So the maximum that should be expand short time debts  and inventories is $ 1,666,667.