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[CMACPA]

Answer the questions for each of the following independent situations
(a)The current ratio is 2.5 to 1; the acid-test ratio is 0.9 to 1; cash and receivables are P270,000. The only current assets are cash, receivables, and inventory. What are current liabilities? What is inventory?
(b)A company had current assets of P600,000.It then ρáíd a current liability of P90,000.After the payment, the current ratio was 2 to 1.What were current liabilities before the payment was made?
(c)A company has a debt ratio of 0.50, a total assets turnover of 0.25, and a profit margin of 10%. The president is unhappy with the current return on equity, and he thinks it could be doubled. This could be accomplished (1) by increasing the profit margin to 14% and (2) increasing debt utilization.Total assets turnover will not change.What new debt ratio, along with the 14% profit margin, is required to double the return on equity?
(d)The company has P1.6 million of accounts receivable on its balance sheet. The company’s DSO is 40 (based on a 360-day year), its current assets are P2.5 million, and its current ratio is 1.5. The company plans to reduce its DSO from 40 to the industry average of 30 without causing a decline in sales. The resulting decrease in accounts receivable will free up cash that will be used to reduce current liabilities. If the company succeeds in its plan, what will it’s new current ratio be? Answer in a step by step solution

 

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(a)
Given:
Current ratio = 2.5
Acid-test ratio = 0.9
Cash and receivables = P270,000
Current assets = Cash + Receivables + Inventory

1. Calculate current liabilities:
Current ratio = Current assets / Current liabilities
2.5 = P270,000 + Inventory / Current liabilities
Current liabilities = (P270,000 + Inventory) / 2.5

2. Calculate inventory:
Acid-test ratio = (Current assets - Inventory) / Current liabilities
0.9 = (P270,000 + Inventory - Inventory) / (P270,000 + Inventory) / 2.5
0.9 = (P270,000) / ((P270,000 + Inventory) / 2.5)
0.9 = 2.5
Inventory = P270,000 + Inventory
0.9*(P270,000 + Inventory) = 2.5*(P270,000)
P243,000 + 0.9*Inventory = P675,000
0.9*Inventory = P432,000
Inventory = P480,000

So, current liabilities = (P270,000 + P480,000) / 2.5 = P750,000 / 2.5 = P300,000

Therefore, current liabilities are P300,000 and inventory is P480,000.

(b)
Given:
Current assets = P600,000
Current liabilities after payment = P90,000
Current ratio after payment = 2

1. Calculate current liabilities before the payment:
Current ratio = Current assets / Current liabilities
2 = P600,000 / Current liabilities
Current liabilities = P600,000 / 2
Current liabilities = P300,000

Therefore, current liabilities before payment were P300,000.

(c)
Given:
Debt ratio = 0.50
Total assets turnover = 0.25
Profit margin = 0.10

1. Calculate return on equity (ROE):
ROE = Profit margin * Total assets turnover * Equity multiplier
ROE = 0.10 * 0.25 * (1 + Debt ratio)
ROE = 0.025 * (1 + 0.50)
ROE = 0.025 * 1.50
ROE = 0.0375 or 3.75%

2. Calculate new debt ratio needed to double ROE with a profit margin of 0.14:
ROE = 0.14 * 0.25 * (1 + New debt ratio)
0.0375 * 2 = 0.14 * 0.25 * (1 + New debt ratio)
0.075 = 0.035 * (1 + New debt ratio)
2.143 = 1 + New debt ratio
New debt ratio = 1.143 or 114.3%

Therefore, to double the return on equity with a profit margin of 14%, the new debt ratio required is 114.3%.

(d)
Given:
Accounts receivable = P1.6 million
DSO = 40
Current assets = P2.5 million
Current ratio = 1.5
Industry average DSO = 30

1. Calculate current liabilities and current assets without accounts receivable:
Current assets without accounts receivable = P2.5 million - P1.6 million = P0.9 million
Current liabilities = Current assets without accounts receivable / Current ratio
Current liabilities = P0.9 million / 1.5 = P0.6 million

2. Calculate new accounts receivable after DSO reduction:
New DSO = 30
Accounts receivable turnover = 360 / DSO
New accounts receivable = Accounts receivable turnover * Daily sales
New accounts receivable = (360 / 30) * (P1.6 million / 360)
New accounts receivable = P0.533 million

3. Calculate new current assets and current liabilities after DSO reduction:
New current assets = Current assets without accounts receivable + New accounts receivable
New current assets = P0.9 million + P0.533 million = P1.433 million
New current liabilities = Current liabilities (unchanged) = P0.6 million

4. Calculate new current ratio:
New current ratio = New current assets / New current liabilities
New current ratio = P1.433 million / P0.6 million
New current ratio = 2.388

Therefore, after the successful plan, the new current ratio will be 2.388.

 

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