(Understanding the impact of transactions on financial ratios, LO 4, 7) Victoria Ltd. (Victoria) is a small tool and die manufacturer in British Columbia. Victoria recently obtained financing from a local bank for an expansion of the company’s facilities. The agreement with the bank requires that Victoria’s current ratio and debtto-equity ratio be within ranges stated in the agreement. If the ratios fall outside of these ranges Victoria would have to repay the new loans immediately. At this time Victoria has a current ratio of 1.80 (based on current assets of $900,000 and current liabilities of $500,000) and a debt-to-equity ratio of 2 to 1 (based on total liabilities of $2 million and total equity of $1 million). The chief financial officer of Victoria is concerned about the effect a number of transactions scheduled for the last few days of the year will have on the company’s current ratio and debt-to-equity ratio.

Required:
Determine the effect that each of the following transactions will have on the current ratio and the debt-to-equity ratio. Calculate what each ratio will be after each transaction takes place and indicate the effect each transaction has on each ratio (increase, decrease, or no effect). Treat each item independently.

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Transaction Example: $27,000 owing from customers is collected. 1. Purchase of equipment for $150,000. The supplier of the equipment must be paid in two years. 2. Purchase of inventory for $40,000 cash. The inventory was unsold at the end of the year. 3. Sale of capital stock to investors for $300,000 cash. 4. Declaration and payment of $100,000 of dividends. 5. Repayment of $150,000 on a long-term loan. 6. Repayment of $75,000 on a short-term bank loan. 7. Dividends of $50,000 are declared and will be paid after the year end. (Once the dividends have been declared they become a liability called Dividends Payable.) Effect of the transaction Debt-to- Current ratio on the current ratio equity ratio 1.80 No effect 2 to 1 Effect of the transaction on the debt-to- equity ratio No effect