Why does the cash balance stay unchanged at the start of Year 1 in the scenario where factory investment is financed by debt?

Why does the cash balance stay unchanged at the start of Year 1 in the scenario where factory investment is financed by debt?

• A. The income statement records a $100 expense.
• B. The balance sheet PP&E decreases by $100.
• C. The cash flow statement shows an investment outflow and a financing inflow of equal magnitude, net zero.
• D. The debt is recorded as revenue.

Answer: (C)

When you finance a factory purchase with debt, the cash effects in the period cancel each other out. The company spends cash to buy the factory (investing activity), and at the same time borrows cash (financing activity). If those two cash flows are equal in size in the same period, the net change in cash is zero, so the cash balance remains unchanged at the start of Year 1. On the balance sheet, PP&E increases by the cost of the factory and liabilities (the debt) increase by the same amount. The income statement doesn’t reflect this financing right away—capital expenditures aren’t expensed immediately. Debt isn’t revenue either; it’s a liability.

When you finance a factory purchase with debt, the cash effects in the period cancel each other out. The company spends cash to buy the factory (investing activity), and at the same time borrows cash (financing activity). If those two cash flows are equal in size in the same period, the net change in cash is zero, so the cash balance remains unchanged at the start of Year 1. On the balance sheet, PP&E increases by the cost of the factory and liabilities (the debt) increase by the same amount. The income statement doesn’t reflect this financing right away—capital expenditures aren’t expensed immediately. Debt isn’t revenue either; it’s a liability.