A construction company has the following for the month: Beginning cash $25,000, Cash receipts $180,000, Cash payments $195,000. The company has a line of credit that requires maintaining a minimum cash balance of $15,000. How much must be borrowed?
Correct Answer
A) $5,000
Ending cash without borrowing: $25,000 + $180,000 - $195,000 = $10,000. Since the minimum required balance is $15,000, the company must borrow $5,000 to meet the covenant requirement.
Why This Is the Correct Answer
The correct answer is B ($5,000) because we must first calculate the ending cash balance without borrowing, which is $25,000 + $180,000 - $195,000 = $10,000. Since the line of credit covenant requires maintaining a minimum balance of $15,000, and the company would only have $10,000, they must borrow exactly $5,000 to meet the $15,000 minimum requirement. This borrowing amount brings the cash balance to exactly the required minimum.
Why the Other Options Are Wrong
Option B: $10,000
Option C is wrong because borrowing $10,000 would result in a cash balance of $20,000 ($10,000 ending balance + $10,000 borrowed), which exceeds the minimum requirement and represents unnecessary borrowing costs.
Option C: $0
Option D is wrong because borrowing $15,000 would result in a cash balance of $25,000 ($10,000 ending balance + $15,000 borrowed), which is $10,000 more than the minimum requirement and would incur unnecessary interest expense.
Option D: $15,000
Option A is wrong because borrowing $0 would leave the company with only $10,000 in cash, which is $5,000 below the required minimum balance of $15,000, violating the line of credit covenant.
Memory Technique
Remember 'BRP-M': Beginning + Receipts - Payments = actual balance, then compare to Minimum requirement to find borrowing need
Reference Hint
Business and Finance for Contractors - Chapter on Cash Flow Management and Banking Relationships
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