Taking out a Loan or Asset

Accounting Data:

Ratio Firm A Firm B
Current Ratio 1.2 1.6
Debt Ratio 0.2 0.5
Asset Turnover 2 6
Quick Ratio 1.1 0.9
TIER 2 5
Inventory Turnover 7 1
Accounts Receivable Turnover 1 5
P/E ratio 15 20

Question:
Which of the two firms is less likely to take out a loan or sell an asset to meet current expenses? Please assume that for both firms their inventories are extremely firm specific.

(a) Firm B since the Current ratio is larger.
(b) Firm A since the Current ratio is smaller.
(c) Firm B since the Quick ratio is smaller.
(d) Firm A since the Quick ratio is larger.

Answer:
(d) Firm A since the Quick ratio is larger

Explanation:
When looking at if a firm is more or less likely to take out a loan or sell an asset, there are two ratios to consider: current and quick. This question tells us that both firms' inventories are extremely firm specific. When inventory is difficult to sell, we look at the quick ratio. A higher quick ratio means a lower probability the firm will take out a loan or sell an asset.

Answer:
(d) Firm A since the Quick ratio is larger. We won't consider current ratio because the company is not selling much of it's inventory.
When the quick ratio is larger the company has more assets, which is why it won't take out a loan.

Unless otherwise stated, the content of this page is licensed under Creative Commons Attribution-ShareAlike 3.0 License