MKTG (with Marketing CourseMate with eBook Printed Access Card)

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WORKING WITH FINANCIALSTATEMENTS Answers to Concepts Review and Critical Thinking Questions1. a. If inventory is purchased with cash, then there is no change in the current ratio. If inventory ispurchased on credit, then there is a decrease in the current ratio if it was initially greater than1.0. b. Reducing accounts payable with cash increases the current ratio if it was initially greater than1.0. c. Reducing short-term debt with cash increases the current ratio if it was initially greater than 1.0. d. As long-term debt approaches maturity, the principal repayment and the remaining interestexpense become current liabilities. Thus, if debt is paid off with cash, the current ratio increasesif it was initially greater than 1.0. If the debt has not yet become a current liability, then payingit off will reduce the current ratio since current liabilities are not affected. e. Reduction of accounts receivables and an increase in cash leaves the current ratio unchanged. f. Inventory sold at cost reduces inventory and raises cash, so the current ratio is unchanged. g. Inventory sold for a profit raises cash in excess of the inventory recorded at cost, so the currentratio increases. 2. The firm has increased inventory relative to other current assets; therefore, assuming currentliability levels remain mostly unchanged, liquidity has potentially decreased. 3. A current ratio of 0.50 means that the firm has twice as much in current liabilities as it does incurrent assets; the firm potentially has poor liquidity. If pressed by its short-term creditors andsuppliers for immediate payment, the firm might have a difficult time meeting its obligations. Acurrent ratio of 1.50 means the firm has 50% more current assets than it does current liabilities. Thisprobably represents an improvement in liquidity; short-term obligations can generally be met com-pletely with a safety factor built in. A current ratio of 15.0, however, might be excessive. Anyexcess funds sitting in current assets generally earn little or no return. These excess funds might beput to better use by investing in productive long-term assets or distributing the funds toshareholders. 4.
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This document was uploaded on 03/07/2012.

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