‘Felicia & Fred recently hired a new designer who has considerable experience in product development of handbags and small leather goods. The intent was for the designer to initially work with the company’s innovation team to introduce a gift with purchase (GWP): a logo wristlet purse that can accommodate a Smartphone. This GWP will be offered as a limited edition during the holiday season and customers or recipients will be encouraged through social media to participate in a survey regarding the product to determine future potential demand for handbags and other small leather goods bearing the Felicia & Fred logo.
The potential inclusion of handbags as part of the company’s product will require significant addition to the total value of Felicia & Fred’s working capital. The entire mix of assets and liabilities as part of the balance sheet might change.
Consider the following:
In order to maintain the company’s debt covenants, it must maintain a current ratio of 1.5. Its current ratio is presently 1.75 and has been maintained at that level for some time. What happens to a company’s current ratio if it takes on additional short-term debt or accounts payable to fund current assets when the current ratio is greater than one? Or Less than one?
Given your consideration of the part 2 result, should the company fund a working capital increase with short-term debt or long-term debt?
Solution:Working capital or the net working capital is the difference between current assets and current liabilitiesof a company. It is the amount of money required to meet its short term day to…