Question

Zen, Inc. is a merchandiser of herbal teas and begin operations on January 1. The company expects sales in its first month of operations to total $2,500. All sales will be cash sales. Inventory purchases during January are expected to equal $600. Purchases are paid for in the month following the month of purchase. No purchase discounts are available. Zen's expected monthly operating expenses are $1,750, $500 of which is for depreciation. No timing differences exist between when cash operating expenses are incurred and when they are paid. Zen currently has no debt but does plan to pay a cash dividend of $900 to its owners in January.

Zen is required to maintain a minimum cash balance of $1,000 at the end of each month by its bank. How much would Zen need to borrow from an established line of credit in January if it makes no adjustments to the above plan?

A. $1,150 (wrong)
B. $650
C. $850
D. $1,250
E. $1,000

Answer 1

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Ans:

B. $650

Workings: Calculation of Zen needs to borrow from an established line of credit in January:

Particulars	Amount in $
1. Cash inflow for sales in January	2,500
2. Cash outflow for operting expenses excluding depreciation (1,750 - 500)	(1,250)
3. Cash outflow for cash dividend	(900)
4. Remaining Cash balance (1-2-3)	350
5. Cash balance needs to be maintained	1,000
6. Needs to borrow in the month of January (5-4)	650

Note:

1. Purchase made in January, will be pain in the february. Hence, it's not a cash outflow.

2. Depreciation is not a cash outflow.

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