Question

A business begins with $1,000,000 from its owners. It places $100,000 into a bank account which it wishes to maintain as a cash reserve. It needs to purchase $1,000,000 of equipment and materials. How much does it need to borrow?

Answer is $900,000.00. Please explain thoroughly why the answer is $900K.

Answer 1

Total amount that has been put in the business is $1,000,000

As owner want to maintain $100,000 as cash reserve with bank that means it does not going to utilize this $100,000 for any investment purpose. So the amount available is 1,000,000-100,000 = 900,000

So if it wants to purchase $1,000,000 equipment and material it need to borrow (1,000,000-900,000) i.e. $100,000

Alternate solution:

We know: Total Assets = Total Equity + Total debt

Here total asset = cash reserve + equipment & material

Total assets = 100,000 + 1,000,000 = $1,100,000

Also total equity = $1,000,000 (i.e amount invested by owner)

So 1,100,000 = 1,000,000 + total debt

Or Total debt = 1,100,000-1,000,000 = $100,000

So if the answer given is $900,000 then it is incorrect or some more information should be there, it should be $100,000 only for given question