Vance Motors has current assets of $1.2 million. The company's current ratio is 1.2, its quick ratio is 0.7, and its inventory turnover ratio is 4. The company would like to increase its inventory turnover ratio to the industry average, which is 5, without reducing its sales. Any reductions in inventory will be used to reduce the company's current liabilities. What will be the company's current ratio, assuming that it is successful in improving its inventory turnover ratio to 5?
A) 1.33
B) 1.67
C) 1.22
D) 0.75
E) 2.26

Question

Quizplus · Accepted Answer

To increase the inventory turnover ratio to 5, the company needs to reduce its inventory by:

Inventory reduction = (4/5 - 1) x Sales = - 0.2 x Sales

This means that the company needs to reduce its inventory by 20% to achieve the target inventory turnover ratio.

The company's current inventory can be calculated as:

Inventory = Current assets x (1 - Quick ratio) 
Inventory = $1.2 million x (1 - 0.7) = $360,000

To reduce inventory by 20%, the company needs to reduce it by:

Inventory reduction = 0.2 x $360,000 = $72,000

Assuming the reduction in inventory is used to reduce current liabilities, the company's current liabilities will decrease by $72,000, and its current assets will decrease by the same amount.

New current assets = $1.2 million - $72,000 = $1.128 million

New current ratio = Current assets / Current liabilities 
New current ratio = $1.128 million / ($1.2 million - $72,000) 
New current ratio = $1.128 million / $1.128 million 
New current ratio = 1.0

Therefore, the company's new current ratio will be 1.0 after successfully improving its inventory turnover ratio to 5. However, none of the answer choices are correct, as they all differ from the correct answer of 1.0.

Vance Motors Has Current Assets of $1