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_____________

Answer 1

Royal Industries has a cash shortage of $3,000 at the end of January and must borrow this amount to cover the shortage and maintain their desired cash cushion. With an interest rate of 1% per month, they would incur an interest expense of $30 for this borrowing in February.

Step-by-step explanation:

To calculate the amount of interest paid in February, we need to identify if Royal Industries has a cash shortage at the end of January and the amount they need to borrow. Based on the given budgeted information, the cash deficiency at the end of January would be calculated as:

Ending Cash Balance = Beginning Cash Balance + Cash Receipts - Cash Payments - Desired Ending Cash Cushion

= $10,000 + $40,000 - $48,000 - $5,000

= -$3,000 (This indicates a cash shortage of $3,000.)

Since the company needs to maintain a cash cushion of $5,000, they will borrow $3,000 to cover the shortfall. Then, the amount of interest the company has to pay in February would be 1% of the amount borrowed.

Interest Payment = Amount Borrowed × Interest Rate

= $3,000 × 1%

= $30

So, the amount of interest paid in February by Royal Industries would be $30.