How might borrowing $1 million long-term and investing the proceeds in inventory affect cash and net working capital?
Borrowing $1 million and investing the proceeds will increase the cash and net working capital by $1 million less the interest charges.
To understand how borrowing $1 million long-term and investing the proceeds in inventory might affect cash and net working capital, let's break it down step by step.
1. Borrowing $1 million: This means taking a loan of $1 million from a lender, which will increase the cash balance by $1 million.
2. Investing the proceeds in inventory: The borrowed amount, which is now in the form of cash, is used to purchase inventory. This increases the inventory balance by $1 million.
Now, let's look at how this affects cash and net working capital:
1. Cash: Initially, borrowing the $1 million increases the cash balance by $1 million. However, over time, you will have to repay the loan amount along with interest charges. The interest charges will reduce the cash balance, so you need to account for those.
2. Net working capital: Net working capital is calculated by subtracting current liabilities from current assets. In this scenario, the cash and inventory will both be considered as current assets.
Initially:
- Cash increases by $1 million.
- Inventory increases by $1 million.
Ongoing:
- Over time, as loan repayments and interest charges are made, the cash balance will decrease.
- If the loan is long-term, it may have minimal impact on net working capital, as long-term debt is not classified as a current liability. However, you need to consider the interest payments on the loan as a current liability.
In summary, borrowing $1 million and investing it in inventory will initially increase both cash and net working capital by $1 million. However, the ongoing impact will depend on the repayment of the loan and the interest charges.