Part two 1. Liquidity ratios Aa Aa Most firms borrow money to finance some of th
ID: 2813338 • Letter: P
Question
Part two1. Liquidity ratios Aa Aa Most firms borrow money to finance some of their assets, and most will choose to borrow some long-term funds and some short-term funds. Which group of lenders would put greater emphasis on a firm's liquidity ratio when evaluating a potential borrower? O Long-term lenders O Short-term lenders The most recent data from the annual balance sheets of Pellegrini Southem Inc. and Scramouche Opera Company are as follows: Balance Sheet December 31st (Millions of dollars) Scramouche Pellegrini Scramouche Pellegrini Southern Opera Company Southern Inc. Opera Company Inc. Assets Current assets Current liabilities Cash Accounts receivable Inventories $1,476 Accounts payable $o $2,296 840 2,464 5,600 $0 506 2,869 3,375 4,125 7,500 540 Accruals 1,584 Notes payable 3,600 Total current liabilities 2,700 2,700 3,300 6,000 Total current assets Net fixed assets Long-term bonds Net plant and equipment 4,400 4,400 Total debt Common equity 1,625 875 2,500 10,000 1,300 700 2,000 Common stock Retained earnings Total common equity Total liabilities and equity Total assets 10,000 8,000 8,000
Explanation / Answer
Part 1:
Short-term lenders put more emphasis on liquidity than long term lenders. This is important for the short term lenders as the borrower may not have enough money in short term to pay back the loan. Long term borrower may still have time to generate the amount that could be paid back.
Part 2:
Current Ratio = Current Assets/Current Liabilities
Quick Ratio = (Current Assets - Inventory)/Current Liabilities
Pellegrini South: Current Ratio = 3600/2700 = 1.3333; Quick Ratio = (3600 - 1584)/2700 = 0.7467
Scramouche Company: Current Ratio = 5600/3375 = 1.6593; Quick Ratio = (5600 - 2464)/3375 = 0.9292
Part 3:
True statements are - Statement 1 and 3.
Quick ratio for Scramouche Opera is better, hence better liquidity. So statement 1 is true.
If company's liabilities are increasing at a faster rate (its current ratio/quick ratio will decline), company's liquidity is weakening and hence statement 2 is false.
Statement 3 is true. difference between current ratio and quick ratio is the result of reliance on annuities.
Statement 4 is false as Scramouche has a better liquidity position (higher quick ratio)
STatement 5 is false. Increase in current position does not always mean that liquidity is imporving. It might also be caused due to piling up of inventories, which may become obsolete and hence become illiquid.