Question

Assume that XYZ tires has the following totals on its balance sheet:

Assets: $100,000

Liabilities: $40,000

XYZ Tires now borrows $50,000 from the bank.

1. How will the totals for assets and liabilities be affected by the loan? Explain.

2. Is the borrowing a good idea for the business? Why or why not?

3. How might the business use the $50,000?

4. What other information would be useful to have before deciding to take out the loan?

Answer 1

SOLUTION:

1)If the borrowings is $50000 from the bank.It increase the liabilities by $50000,in borrowings columns,hence the total liabilities will $40000+50000=$90000.Also, the assets increase by $50000 either in bank or cash column, so the total assets will be 100000+50000= $150000.It is affected by loan because any borrowings or payment leads to increase or decrease in assets and liabilities of a company.

2)Yes,Depending on the needs and situations it is either to borrow or not to borrow.A loan is a good idea because a loan is a better source of capital for a business in comaprison with share capital as a business can have a better leverage.The company enjoys the surplus of rate of return over the interest paid on trhe borrowings.

To borrow money is not a good idea because it provide burden on the company of the interest on loan on regular basis,either the company has earning or not.Sometimes companies failed to repay the loan,that will lead company even to liquidation.

3)Business might use the $50000 to purchase raw materials,or to increase its working capital requirements,or to expand the business,or to increase the production capacities.Depending on the use and situations, a company might use it.

4)The actual need for the loan is most important before taking out loan,is there any possibility to manage without loan.The interest rate and the period of time for which the loan is taken is considered beforre taking it.The source of earning is enough to pay interest on loan on time.Mainly the total interest on entire loan is not too much.