The December 31, 1995 balance sheet for Spitco, Inc. is presented below.
Spitco, Inc. Balance Sheet December 31, 2010 Current assets $40,000 Net fixed assets 20,000 Total $60,000 Accounts payable 11,000 Notes payable 12,000 Total $23,000 Long-term debt (10%) 12,000 Common equity 25,000 Total $60,000 a. Calculate Spitco’s current ratio, and net working capital. b. Spitco feels that its current ratio is too far below the industry average of 2.40. To improve their liquidity, the treasurer of Spitco has devised a plan to issue $12,000 in long-term debt at 12% and pay off its notes payable. The funds would be invested in marketable securities at 7% interest when not needed to finance the firm’s seasonal asset needs. The notes payable would remain outstanding through the year. Assume this plan had been implemented for 2010. Calculate what the firm’s current ratio, and net working capital would have been. c. Did Spitco improve their liquidity? What do you think happened to Spitco’s return on investment?
Darshita Changed status to publish August 7, 2020
Answer:
a)
Current ratio
= (current assets)/(current liabilities)
= ($40,000)/($23,000)
= 1.74x
Net working capital
= current assets – current liabilities
= $40,000 – $23,000
= $17,000
b)
Current ratio
= (current assets)/(current liabilities)
= ($40,000)/($11,000)
= 3.64x
Net working capital
= current assets – current liabilities
= $40,000 – $11,000
= $29,000
c) Yes, liquidity is good then the industry average. The firm’s return on investment has probably fallen.
Darshita Changed status to publish August 7, 2020
