An analyst gathers the following information (in $ millions) about three companies:Company 1 Company 2 Company 3Cash 2.5 2.0 1.5Short-term marketable instruments 4.0 1.0 1.0Receivables 2.0 2.0 1.0Inventory 1.0 1.0 3.0Current liabilities 5.0 2.5 2.0Based on the quick ratio, which company exhibits the lowest liquidity risk?A.Company 1B.Company 2C.Company 3
Question
An analyst gathers the following information (in $ millions) about three companies:Company 1 Company 2 Company 3Cash 2.5 2.0 1.5Short-term marketable instruments 4.0 1.0 1.0Receivables 2.0 2.0 1.0Inventory 1.0 1.0 3.0Current liabilities 5.0 2.5 2.0Based on the quick ratio, which company exhibits the lowest liquidity risk?A.Company 1B.Company 2C.Company 3
Solution
The quick ratio is calculated as (Cash + Short-term Marketable Instruments + Receivables) / Current Liabilities. It is a measure of a company's ability to cover its current liabilities with its most liquid assets (excluding inventory). The higher the quick ratio, the lower the liquidity risk.
Let's calculate the quick ratio for each company:
Company 1: (2.5 + 4.0 + 2.0) / 5.0 = 1.7 Company 2: (2.0 + 1.0 + 2.0) / 2.5 = 2.0 Company 3: (1.5 + 1.0 + 1.0) / 2.0 = 1.75
Based on the quick ratio, Company 2 exhibits the lowest liquidity risk. So, the answer is B. Company 2.
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