A Level Accounting (9706)•9706/11/O/N/23
Explanation
Loan's Impact on Liquidity and Profitability Ratios
Steps:
- The $40,000 loan increases cash, a current asset, with no change to current liabilities, raising the current ratio (current assets / current liabilities).
- The five-year loan is a long-term liability, increasing capital employed (equity + long-term liabilities).
- ROCE (EBIT / capital employed) decreases as the denominator grows without an immediate EBIT rise.
- Thus, current ratio increases while ROCE decreases.
Why C is correct:
- C matches the effects: current ratio rises from higher current assets; ROCE falls per the formula as capital employed expands via long-term debt.
Why the others are wrong:
- A: Wrong; current ratio increases, not decreases.
- B: Wrong; current ratio increases, and ROCE decreases.
- D: Wrong; ROCE decreases, not increases.
Final answer: C
Topic: Analysis and communication of accounting information
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