The opposite effects on profit and risk result from a

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Unformatted text preview: ssets Increase Increase Increase Decrease Decrease Decrease Ratio it is. The opposite effects on profit and risk result from a decrease in the ratio of current assets to total assets. Changes in Current Liabilities How changing the level of the firm’s current liabilities affects its profitability–risk tradeoff can be demonstrated by using the ratio of current liabilities to total assets. This ratio indicates the percentage of total assets that has been financed with current liabilities. Again, assuming that total assets remain unchanged, the effects on both profitability and risk of an increase or decrease in the ratio are summarized in the lower portion of Table 14.1. When the ratio increases, profitability increases. Why? Because the firm uses more of the less expensive current liabilities financing and less long-term financing. Current liabilities are less expensive because only notes payable, which represent about 20 percent of the typical manufacturer’s current liabilities, have a cost. The other curre...
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