When firms enter into loan agreements with their bank, it is very common for the agreement to have a restriction on the minimum current ratio the firm has to maintain. So, it is important that the firm be aware of the effects of their decisions on the current ratio. Consider the situation of Advanced Autoparts (AAP) in 2009. The firm has total current assets of $1,780,195,300 and current liabilities of $1,369,381,000.What is the firm’s current ratio?If the firm were to expand its investment in inventory and finance the expansion by increasing accounts payable, how much could it increase its inventory without reducing the current ratio below 1.2?If the company needed to raise its current ratio to 1.5 by reducing its investment in current assets and simultaneously reducing accounts payable and short-term debt, how much would it have to reduce current assets to accomplish this goal?

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Description: When firms enter into loan agreements with their bank, it is very common for the agreement to have a restriction on the minimum current ratio the firm has to maintain. So, it is important that the firm be aware of the effects of their decisions on th

Current Ratio = Current Assets/ Current Liabilities

Answered: When firms enter into loan agreements…

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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When firms enter into loan agreements with their bank, it is very common for the agreement to have a restriction on the minimum current ratio the firm has to maintain. So, it is important that the firm be aware of the effects of their decisions on the current ratio. Consider the situation of Advanced Autoparts (AAP) in 2009. The firm has total current assets of $1,780,195,300 and current liabilities of $1,369,381,000.
1. What is the firm’s current ratio?
2. If the firm were to expand its investment in inventory and finance the expansion by increasing accounts payable, how much could it increase its inventory without reducing the current ratio below 1.2?
3. If the company needed to raise its current ratio to 1.5 by reducing its investment in current assets and simultaneously reducing accounts payable and short-term debt, how much would it have to reduce current assets to accomplish this goal?

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