Ronaldinho Trading Co. is required by its bank to maintain a current ratio of at least 1.75, and its current ratio now is 2.1. The firm plans to acquire additional inventory to meet an unexpected surge in the demand for its products and will pay for the inventory with short-term debt. How much inventory can the firm purchase without violating its debt agreement, if their total current assets equal $3.5 million? Round your final answer to the nearest dollar.
A) $0
B) $777,777
C) $1 million
D) None of the above

Question

Quizplus · Accepted Answer

To maintain a current ratio of at least 1.75, the maximum amount of inventory the firm can purchase without violating its debt agreement can be calculated using the formula for the current ratio, which is Current Assets / Current Liabilities. Let X be the amount of inventory purchased with short-term debt. The new current assets would be $3.5 million + X, and the new current liabilities would be the original current liabilities (which can be calculated as $3.5 million / 2.1) plus X. Setting up the equation to maintain a current ratio of 1.75, we get: ($3.5 million + X) / (($3.5 million / 2.1) + X) = 1.75. Solving for X gives us approximately $777,777.