The Nelson Company has $1,196,000 in current assets and $460,000 in current liabilities. Its initial inventory level is $325,000, and it will raise funds as additional notes payable and use them to increase inventory. How much can Nelson's short-term debt (notes payable) increase without pushing its current ratio below 2.0

The amount by which Nelson's short-term debt (notes payable) increase without pushing its current ratio below 2.0 is $138,000.

Explanation:

From the question, we have:

Initial current assets = $1,196,000

Initial current liabilities = $460,000

Initial inventory level = $325,000

Targeted current ratio = 2.0

Therefore, we have:

Initial current ratio = Initial current assets / Initial current liabilities = $1,196,000 / $460,000 = 2.60

New current liabilities = Initial current assets / Targeted current ratio = $1,196,000 / 2 = $598,000

Expected amount of increase in short-term debt = New current liabilities - Initial current liabilities = $598,000 - $460,000 = $138,000

By implication, we have:

Expected amount of increase in inventory level = Expected amount of increase in short-term debt = $138,000

New inventory level = Initial inventory level + Expected amount of increase in inventory level = $325,000 + $138,000 = $463,000

New current assets = Initial current assets + Expected amount of increase in inventory level = $1,196,000 +$138,000 = $1,334,000

We can now check as follows:

New current ratio = New current assets / New current liabilities = $1,334,000 / $598,000 = 2.23

Therefore, the amount by which Nelson's short-term debt (notes payable) increase without pushing its current ratio below 2.0 is $138,000.

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