Answer:
Current ratio will increase
Quick ratio will increase
Explanation:
Note: The complete question is what will happen to Current ratio and the Quick ratio if Tosh Enterprises uses cash to pay 25% of the accounts payable?
These can be determined as follows:
a. Initial values
Current assets = Accounts receivable + Cash + Inventory + Short-term prepaid expense = $400,000 + $200,000 + $800,000 + 80,000 = $1,480,000
Current liabilities = Accounts payable + Interest payable, due in 3 months = $260,000 + $20,000 = $280,000
Initial current ratio = Current assets / Current liabilities = $1,480,000 / $280,000 = 5.29
Initial Quick ratio = (Current assets - Inventory) / Current liabilities = ($1,480,000 - $800,000) / $280,000 = 2.43
b. New values
20% of Accounts payable = 260,000 * 20% = $52,000
If Tosh Enterprises uses cash to pay 25% of the accounts payable, both the current assets and liabilities will fall by $52,000 by subtracting it from each of them to obtain new values as follows:
New current assets = $1,480,000 - $52,000 = $1,428,000
New current liabilities = $280,000 - $52,000 = $228,000
New current ratio = New current assets / New current liabilities = $1,428,000 / $228,000 = 6.26
New quick ratio = (New current assets - Inventory) / New current liabilities = ($1,428,000 - $800,000) / $228,000 = 2.75
c. Summary and Conclusion
Since the initial current ratio of 5.29 is less than the new current ratio of 6.26, this shows that current ratio will increase if Tosh Enterprises uses cash to pay 25% of the accounts payable.
Also, since initial quick ratio of 2.43 is less than the new qucik ratio of 2.75, this also shows that quick ratio will increase if Tosh Enterprises uses cash to pay 25% of the accounts payable.
Therefore we have:
Current ratio will increase
Quick ratio will increase
