Jake Company borrowed $100,000 from Guaranty Trust Bank to finance the purchase of new equipment. The loan contract provides for a 12 percent annual interest rate and states that the principal must be paid in full in ten years. The contract also requires that Jake maintains a current ratio of 1.5:1. Before Jake borrowed the $100,000, the company's current assets and current liabilities were $120,000 and $68,000 respectively.
If Jake invests $50,000 of the borrowed funds in equipment and keeps the rest as cash or short-term investment, what is the maximum amount of current liabilities it could have without violating the debt contract?
A)$45,333
B)$146,667
C)$125,333
D)$113,333

Question

Quizplus · Accepted Answer

First, we need to calculate the amount of interest Jake will pay on the loan annually: 
$100,000 x 0.12 = $12,000

Next, we need to calculate the amount of current assets Jake needs to maintain to satisfy the current ratio requirement: 
$120,000 ÷ 1.5 = $80,000

Now, we can use the remaining funds ($50,000) to calculate the maximum amount of current liabilities Jake can have:

Total current assets = $120,000 + $50,000 = $170,000

Total current liabilities = x

$170,000 ÷ 1.5 = x

x = $113,333

Therefore, the maximum amount of current liabilities Jake can have without violating the debt contract is $113,333.

Jake Company Borrowed $100,000 from Guaranty Trust Bank to Finance