MGT201 GDB Solution Spring 2017

Discussion Question:

Sehgal Manufacturers is facing an issue of managing its working capital needs, management is worried about financing of daily operations. Although sales of company have an increasing trend but still company is facing shortage of cash. Liquidity analysis of the company’s financial data showed that company has current ratio of 1.3:1 and management wants an improvement in the current ratio. Financial manager of the company has suggested following two alternatives:

  1. Acquiring short term loan of Rs. 100,000 at 12% annual interest rate
  2. Reducing current liabilities by paying off short-term debt of Rs. 200,000 using marketable securities (Ignore gain or loss on sale of marketable securities)

Following information has been extracted from the financial statements for the analysis:

Particulars Rs. Particulars Rs.
Cash 200,000 Account payables 100,000
Fixed assets 1,500,000 Accruals 150,000
Inventory 150,000 Short term debt 250,000
Net Income 725,250 10-year Bonds 150,000
Account receivables 100,000 Marketable securities 200,000

You are required to discuss the impact of each alternative on current ratio (calculations of current ratio in both cases is mandatory as working carries marks) and suggest which option company should select to improve the current ratio without pushing up its liabilities?  Provide reason to support your selection.

NOTE:

You are required to provide complete calculations along with formulas, otherwise marks will be deducted. Also avoid unnecessary details.

Solution :

Case 1

Current ratio =current assets/current liabilities

750,000/600,000

= 1.25

By acquiring short term loan liability increases although company cash balance increases but intrest payments and loan amount push the liability side up, and current ratio further decreases, so this is not good option.

Case 2

Current ratio =current assets/current liabilities

=  450,000/300,000

= 1.5

In this option when company dispose off its marketable securities for paying loan, assets decrease but liability also decreases with the same amount which improves the current ratio.

Keep in mind members I m not considering intrest etc. This is the idea solution.

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