MFC Corporation has 100,000 shares of stock outstanding. Following is part of MFC's Statement of Financial Position for the last fiscal year.
MFC Corporation Statement of Financial Position - Selected Items
December 31, 2006
Accounts receivable 900,000
Prepaid assets 45,000
Accrued liabilities 285,000
Accounts payable 550,000
Current portion, long-term notes payable 65,000
What is the maximum amount MFC can pay in cash dividends per share and maintain a minimum current ratio of 2 to 1? (Assume that all accounts other than cash remain unchanged.)
$2.50 per share
To determine the maximum amount that MFC can pay in cash dividends per share and maintain a minimum current ratio of at least 2 to 1, you must set up an algebraic problem based on the current ratio formula:
Total Current Assets ÷ Total Current Liabilities = Current Ratio
We know Total Current Liabilities equals $900,000 and our desired minimum current ratio is 2.0.
We also know cash dividends reduce cash, which reduces Current Assets, and have no affect on Current Liabilities.
Replace these terms with these values and solve for Total Current Assets.If Total Current Assets ÷ $900,000 = 2.0, then Total Current Assets = $1,800,000
If Total Current Assets are now $2,050,000, a maximum of $250,000 may be paid out in cash dividends to keep Total Current Assets from dropping below $1,800,000 ($2,050,000 - $1,800,000 = $250,000).
$250,000 of cash dividends divided by 100,000 of stock outstanding equals $2.50 per share ($250,000 ÷ 100,000 = $2.50).