Chapter 8, Problem 2AP

1.

To determine

Ascertain the current ratio for the past two year, and discuss whether the current ratio improve or weaken in the most recent year.

Explanation of Solution

Current ratio: The financial ratio which evaluates the ability of a company to pay off the debt obligations which mature within one year or within completion of operating cycle is referred to as current ratio. This ratio assesses the liquidity of a company.

Formula:

$\text{Current Ratio}=\frac{\text{Current assets}}{\text{Current}\text{liabilities}}$

The current ratio of Company A for the past two year is as follows:

In 2018:

$\begin{array}{c}\text{Current ratio}=\frac{\text{Current assets}}{\text{Current}\text{liabilities}}\\ =\frac{\$968,530\text{thousand}}{\$485,221\text{thousand}}\\ =2.00\text{times}\end{array}$

In 2017:

$\begin{array}{c}\text{Current ratio}=\frac{\text{Current assets}}{\text{Current}\text{liabilities}}\\ =\frac{\$901,229\text{thousand}}{\$493,783\text{thousand}}\\ =1.83\text{ times}\end{array}$

Conclusion

Therefore, the current ratio in the most recent year (2018) is improved.

2.

To determine

Ascertain the acid test ratio for the past two year, and discuss whether the acid test ratio improve or weaken in the most recent year.

Explanation of Solution

Acid-test ratio: The financial ratio which evaluates the ability of a company to pay off the instant debt obligations is referred to as quick ratio. Quick assets are cash, marketable securities, and accounts receivables. This ratio assesses the short-term liquidity of a company.

Formula:

$\text{Acid-test Ratio}=\frac{\text{Cash}+\text{Accounts Receivable}+\text{Short-term Investments}}{\text{Current Liabilities}}$

The acid test ratio of Company A for the past two year is as follows:

In 2018:

$\begin{array}{c}\text{Acid-test ratio}=\frac{\left(\begin{array}{l}\text{Cash}+\text{Short-term investments}\\ +\text{Accounts receivable}\end{array}\right)}{\text{Current liabilities}}\\ =\frac{\left(\begin{array}{l}\$413,613\text{thousand}+\$0thousand+\\ \$78,304\text{thousand}\end{array}\right)}{\$485,221\text{thousand}}\\ =1.01\text{times}\end{array}$

In 2017:

$\begin{array}{c}\text{Acid-test ratio}=\frac{\left(\begin{array}{l}\text{Cash}+\text{Short-term investments}\\ +\text{Accounts receivable}\end{array}\right)}{\text{Current liabilities}}\\ =\frac{\left(\begin{array}{l}\$378,613\text{thousand}+\$0housand\\ +\$86,634\text{thousand}\end{array}\right)}{\$493,783\text{thousand}}\\ =0.94\text{times}\end{array}$

Conclusion

Therefore, the acid test ratio in the most recent year (2018) is improved.

3.

To determine

Explain the manner in which the current ratio and acid test ratio will change, if Company A used $100 million in cash to pay $100 million in accounts payable.

Explanation of Solution

Calculate current ratio if company used $100 million in current investments to pay $100 million in current accounts payable.

If the company used $100 million in current investments to pay $100 million in current accounts payable, the current assets and the current liabilities both decreases by $100 million. Thus, this transaction increases the current ratio. The calculation is as given below:

$\begin{array}{c}\text{Current Ratio}=\frac{\text{Current assets}}{\text{Current}\text{liabilities}}\\ =\frac{\$968,530\text{ thousand}-\text{\$100,000 thousand}}{\$485,221\text{thousand}-\text{\$100,000 thousand}}\\ =\text{2}\text{.25 times}\end{array}$

Calculate acid-test ratio if company used $100 million in current investments to pay $100 million in current accounts payable.

If the company used $100 million in current investments to pay $100 million in current accounts payable, the quick assets and the current liabilities both decreases by $100 million. Thus, this transaction increases the acid-test ratio. The calculation is as given below:

$\begin{array}{c}\text{Acid-test ratio}=\frac{\left(\begin{array}{l}\text{Cash}+\text{Short-term investments}\\ +\text{Accounts receivable}\end{array}\right)}{\text{Current liabilities}}\\ =\frac{\left[\begin{array}{l}\$413,613\text{thousand}+\$0thousand+\\ \$78,304\text{thousand}-\$100,000\text{ thousand}\end{array}\right]}{\$485,221-\$100,000\text{ thousand}}\\ =1.02\text{times}\end{array}$

Conclusion

Therefore, both current and acid test ratio is increased.