Safeco's current assets total to $20 million versus $10 million of current liabilities,while Risco's current assets are $10 million versus $20 million of current liabilities.Both firms would like to "window dress" their end-of-year financial statements,and to do so they tentatively plan to borrow $10 million on a short-term basis and to then hold the borrowed funds in their cash accounts.Which of the statements below best describes the results of these transactions?
A) The transactions would improve Safeco's financial strength as measured by its current ratio but lower Risco's current ratio.
B) The transactions would lower Safeco's financial strength as measured by its current ratio but raise Risco's current ratio.
C) The transactions would have no effect on the firms' financial strength as measured by their current ratios.
D) The transactions would lower both firms' financial strength as measured by their current ratios.
E) The transactions would improve both firms' financial strength as measured by their current ratios.

Question

Quizplus · Accepted Answer

The key here is to recognize that if the CR is less than 1.0,then a given increase to both current assets and current liabilities will increase the CR,while the reverse will hold if the initial CR is greater than 1.0.Thus,the transactions would make Risco look stronger but Safeco look weaker.Here's an illustration:
Safeco: 11ea856c_8bf1_9918_9aec_650fe3342d61_TB1222_00 Risco: 11ea856c_8bf1_9919_9aec_73ebfbd1f91d_TB1222_00 All of the statements except b are incorrect.

Safeco's Current Assets Total to $20 Million Versus $10 Million