Question

If a firm borrowed money on a six-month bank loan, the firm's working capital immediately after obtaining the loan, relative to its working capital just prior to the loan, would be:

1) Higher.
2) Lower.
3) The same.
4) Would depend on the amount borrowed.

Answer 1

Borrowing through a six-month bank loan increases a firm's working capital immediately after obtaining the loan because it raises current assets without an equivalent immediate increase in current liabilities.

Step-by-step explanation:

When a firm borrows money through a six-month bank loan, its working capital immediately increases relative to its working capital just prior to the loan. This is because working capital is defined as current assets minus current liabilities. By receiving the bank loan, the firm boosts its current assets without an immediate increase in current liabilities, thus increasing the working capital. However, the loan will need to be repaid within six months, which will affect future working capital.

If a firm borrowed money on a six-month bank loan, the firm's working capital immediately after obtaining the loan, relative to its working capital just prior to the loan, would be the same. When a firm borrows money from a bank, it increases its liabilities (debt) but also increases its assets (cash). These changes would offset each other, resulting in no change in the firm's working capital immediately after obtaining the loan.