CFA Practice Question

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CFA Practice Question

Enigma Corporation anticipates that it will have a current ratio of less than one at the end of 2011. What would be the effect on Enigma's current ratio if it raised funds through a short-term loan on the balance sheet date at the end of the year?
A. It would worsen the current ratio.
B. Iy would have no effect on the current ratio.
C. It would improve the current ratio.
Explanation: Current assets are already less than current liabilities and so the current ratio (current asset / current liabilities) is less than one. If one were to borrow funds through a short-term loan at the end of the year, this would increase both current assets (as the new funds are represented as cash) and current liabilities (by the amount of the loan). The effect of this equal increase in current assets and current liabilities will increase the current ratio. This can be proved easily by testing with numbers. Suppose that a company had current assets of $300 and current liabilities of $400. The current ratio is 75%. Suppose that the company then borrows $100 in the form of a short-term loan at the year's end. The calculation of the current ratio now becomes $400 divided by $500, giving a current ratio of 80%.

User Contributed Comments 8

User Comment
SammyD9 c is only correct if we ASSUME the money is kept as cash, as there is no mention of this i think d is correct
cfacfa you thought too much. The question is actually implying what the current ratio would be immediately after the company borrowed short-term loans? You should not go too far and think "what if the company used the money to buy long-term assets, or to pay off its existing loans, or make some long-term investment". That would make our candidates' lives too miserable and nothing would be certain.
gene80 mathematical trick question. damn. denominator is lesser than nominator, equal increase in both would lead to movement towards 1.
octavianus Numerator is less than denominator
example: 1.1/1.5=0.7333

add 1 to numerator and denominator:
Current Ratio increases=improves
wundac Always plug in numbers for this type of question
rana1970 option
A is true if cr>1;
B is true if cr=1;
C is true if cr<1; cr=current ratio
thekobe an increase in the ratio is considered an improvement?? the company is more leveraged!
jasonkwk thekobe,

current ratio =current assset/current liabilities

if ration increase, means asset increase more than liabilities increase.
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