Question

Royal Industries has budgeted the following information for January:

Cash Receipts: $40,000
Beginning Cash Balance: $10,000
Cash Payments: $48,000
Desired Ending Cash Cushion: $5,000
If there is a cash shortage, the company borrows money. If a surplus occurs funds are used to repay loans or to invest in short-term assets. All borrowing, repayments, and interest payments occur on the last day of the month. The interest rate is 1% per month. The company had no debt before January 1st. The amount of interest paid in February would be
a. 2000 available
b. 3,000 needed
c. 7000 available
d. 13,000 needed

Answer 1

Royal Industries needs to borrow $3,000 due to a cash shortfall in January, and the interest it would pay in February on this borrowing at 1% per month is $30.

Step-by-step explanation:

The amount of interest paid in February for Royal Industries can be calculated based on its cash budget. First, we need to ascertain whether there is a cash deficit or surplus at the end of January. To do this, we add the beginning cash balance to the cash receipts and then subtract the cash payments, as well as the desired ending cash cushion from the resulting amount.

Calculation:

• Beginning Cash Balance: $10,000
• + Cash Receipts: $40,000
• - Cash Payments: $48,000
• = Net Cash Position before Cushion: $2,000
• - Desired Ending Cash Cushion: $5,000
• = Cash Deficit: $3,000

Since there is a cash deficit, Royal Industries needs to borrow $3,000. Since all borrowings are made on the last day of the month, and the interest rate is 1% per month, the interest to be paid in February would be:
Interest for February = $3,000 x 1% = $30.

Therefore, the correct answer is (b) $3,000 needed, because Royal Industries must borrow this amount to cover the cash shortfall, and the interest on this borrowing due in February is $30 (though this detail was not part of the multiple-choice answers).