Baker Corp.is required by a debt agreement to maintain a current ratio of at least 2.5,and Baker's current ratio now is 3.Baker wants to purchase additional inventory for its upcoming Christmas season,and will pay for the inventory with short-term debt.How much inventory can Baker purchase without violating its debt agreement if their total current assets equal $15 million?
A) $0.50 million
B) $1.67 million
C) $4.50 million
D) $6.00 million

Question

Quizplus · Accepted Answer

If Baker's current ratio is 3, it means that for every $1 of current liabilities, it has $3 of current assets. In order to maintain a current ratio of at least 2.5, it cannot have less than $2.5 of current assets for every $1 of current liabilities. Therefore, Baker can allocate $10 million ($15 million x 2.5/4.5) towards its current liabilities, leaving $5 million for current assets. If Baker wants to purchase additional inventory, it will have to use part of its current assets. Assuming it uses all of its remaining $5 million for inventory, it will still have a current ratio of 2.5, meeting the debt agreement. Therefore, Baker can purchase up to $5 million of inventory without violating the debt agreement. However, options A, C, and D are all above this amount, so the best choice is B.