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THEORIES:
Working capital management
1. Working capital management involves investment and financing decisions related to:
A. plant and equipment and current liabilities.
B. current assets and capital structure.
C. current assets and current liabilities.
D. sales and credit.
Moderate
3. Short-term financing plans with high liquidity have:
A. high return and high risk
B. moderate return and moderate risk
C. low profit and low risk
D. none of the above
17. The goal of managing working capital, such as inventory, should be to minimize the:
A. costs of carrying inventory
B. opportunity cost of capital
C. aggregate of carrying and shortage costs
D. amount of spoilage or pilferage
Cash Management
Motives for holding cash
7. The transaction motive for holding cash is for:
A. a safety cushion
C. compensating balance requirements
B. daily operating requirements
D. none of the above
Float
8. The difference between the cash balance on the firm's books and the balance shown on the
bank statement is called:
A, the compensating balance
C. a safety cushion
B. float
D. none of the above
Conservative
2. As a company becomes more conservative with respect to working capital policy, it would
tend to have a(n)
124
Financial Management
(B. Working Capital Management)
19. Which of the following statements is correct for a firm that currently has total costs of carrying
and ordering inventory that are 50% higher than total carrying costs?
A. Current order size is greater than optimal
B. Current order size is less than optimal
C. Per unit carrying costs are too high
D. The optimal order size is currently being used
12. The average length of time a peso is tied up in current asset is called the:
A. net working capital.
C. receivables conversion period.
B. inventory conversion period.
D. cash conversion period.
Trade credit
20. With credit terms of 3/8, n/30, what is the customers payment decision date?
A. Three days after the invoice is received.
B. The 8th day is the customers decision date.
C. Anytime during the period, 8th to the 30th.
D. The 30th day is the primary decision date.
Receivables management
13. All of these factors are used in credit policy administration except:
A. credit standards
C. peso amount of receivables
B. terms of trade
D. collection policy
PROBLEMS
Working capital financing
1
. Casie Company turns out 200 calculators a day at a cost of P250 per calculator for materials
and variable conversion cost. It takes the firm 18 days to convert raw materials into
calculator. Casies usual credit terms extended to its customers is 30 days, and the firm
generally pays its suppliers in 20 days.
If the foregoing cycles are constant, what amount of working capital must Casie Company
finance?
A. P1,400,000
C. P 900,000
B. P2,400,000
D. P1,800,000
14. Which of the following statements is most correct? If a company lowers its DSO, but no
changes occur in sales or operating costs, then:
A. the company might well end up with a higher debt ratio.
B. the company might well end up with a lower debt ratio.
C. the company would probably end up with a higher ROE.
D. the company's total asset turnover ratio would probably decline.
15. All but which of the following is considered in determining credit policy?
A. Credit standards
C. Accounts payable deferral period
B. Credit limits
D. Collection efforts
Inventory management
16. The use of safety stock by a firm will:
A. reduce inventory costs
B. increase inventory costs
18. When a specified level of safety stock is carried for an item in inventory, the average
inventory level for that item
A. decreases by the amount of the safety stock.
B. is one-half the level of the safety stock.
C. Increases by one-half the amount of the safety stock.
125
Financial Management
(B. Working Capital Management)
B. 113 days
4
D. 45 days
B. P1,912.50
D. P 188.55
Samaritan Supplies, Inc. has P5 million in inventory and P2 million in accounts receivable. Its
average daily sales are P100,000. The company has P1.5 million in accounts payable. Its
average daily purchases are P50,000. What is the length of the companys cash conversion
period?
A. 50 days
C. 30 days
B. 20 days
D. 40 days
Annual savings
9
. What are the expected annual savings from a lock-box system that collects 150 checks per
day averaging P500 each, and reduces mailing and processing times by 2.5 and 1.5 days
respectively, if the annual interest rate is 7%?
A. P 5,250
C. P 21,000
B. P 13,125
D. P300,000
Days inventory
5
. What is the inventory period for a firm with an annual cost of goods sold of P8 million, P1.5
million in average inventory, and a cash conversion cycle of 75 days?
A. 6.56 days
C. 52.60 days
B. 18.75 days
D. 67.50 days
Receivables management
Carrying cost
10
. The Camp Company has an inventory conversion period of 60 days, a receivable
conversion period of 30 days, and a payable payment period of 45 days. The Camps
variable cost ratio is 60 percent and annual fixed costs of P600,000. The current cost of
capital for Camp is 12%.
If Camps annual sales are P3,375,000 and all sales are on credit, what is the firms carrying
cost on accounts receivable, using 360 days year?
A. P281,250
C. P 20,250
B. P168,750
D. P 56,250
Samaritan Supplies, Inc. has P5 million in inventory and P2 million in accounts receivable. Its
average daily sales are P100,000. The company has P1.5 million in accounts payable. Its
average daily purchases are P50,000. What is the length of the companys inventory
conversion period?
A. 50 days
C. 120 days
B. 90 days
D. 40 days
Average receivables
11
. Caja Company sells on terms 3/10, net 30. Total sales for the year are P900,000. Forty
percent of the customers pay on the tenth day and take discounts; the other 60 percent pay,
on average, 45 days after their purchases.
What is the average amount of receivables?
A. P70,000
C. P77,200
B. P77,500
D. P67,500
Cash management
Economic conversion quantity (ECQ)
7
. Simile Inc. has a total annual cash requirement of P9,075,000 which are to be paid
uniformly. Simile has the opportunity to invest the money at 24% per annum. The company
spends, on the average, P40 for every cash conversion to marketable securities.
What is the optimal cash conversion size?
A. P60,000
C. P45,000
B. P55,000
D. P72,500
12
Opportunity cost
8
. Hyperbole Corporation estimates its total annual cash disbursements of P3,251,250 which
are to be paid uniformly. Hyperbole has the opportunity to invest the money at 9% per
annum. The company spends, on the average, P25 for every cash conversion to marketable
securities and vice versa.
What is the opportunity cost of keeping cash in the bank account?
A. P3,825.00
C. P4,190.00
. Palm Companys budgeted sales for the coming year are P40,500,000 of which 80% are
expected to be credit sales at terms of n/30. Palm estimates that a proposed relaxation of
credit standards will increase credit sales by 20% and increase the average collection period
from 30 days to 40 days. Based on a 360-day year, the proposed relaxation of credit to
standards will result in an expected increase in the average accounts receivable balance of
A. P 540,000
C. P2,700,000
B. P 900,000
D. P1,620,000
Investment in receivables
13
. Currently, La Carlota Company has annual sales of P2,500,000. Its average collection
126
Financial Management
(B. Working Capital Management)
17
period is 45 days, and bad debts are 3 percent of sales. The credit and collection manager
is considering instituting a stricter collection policy, whereby bad debts would be reduced to
1.5 percent of total sales, and the average collection period would fall to 30 days. However,
sales would also fall by an estimated P300,000 annually. Variable costs are 75 percent of
sales and the cost of carrying receivables is 10 percent. Assume a tax rate of 40 percent
and 360 days per year.
What would be the decrease in investment in receivables if the change were made?
A. P 9,688
C. P 96,875
B. P 12,988
D. P129,975
. What is the economic order quantity for the following inventory policy: A firm sells 32,000 bags
of premium sugar per year. The cost per order is P200 and the firm experiences a carrying
cost of P0.80 per bag.
A. 2,000 bags
C. 8,000 bags
B. 4,000 bags
D. 16,000 bags
Annual demand
18
. Marsman Co. has determined the following for a given year:
Economic order quantity (standard order size)
Total cost to place purchase orders for the year
Cost to place one purchase order
Cost to carry one unit for one year
What is Marsmans estimated annual usage in units?
A. 1,000,000
C. 500,000
B. 2,000,000
D. 1,500,000
Comprehensive
Question Nos. 14 through 16 are based on the following data:
Sonata Company is considering changing its credit terms from 2/15, net 30 to 3/10, net 30 in
order to speed collections. At present, 40 percent of Sonata Companys customers take the 2
percent discount. Under the new term, discount customers are expected to rise to 50 percent.
Regardless of the credit terms, half of the customers who do not take the discount are expected
to pay on time, whereas the remainder will pay 10 days late. The change does not involve a
relaxation of credit standards; therefore bad debt losses are not expected to rise above their
present 2 percent level. However, the more generous cash discount terms are expected to
increase sales from P2 million to P2.6 million per year. Sonata Companys variable cost ratio is
75 percent, the interest rate on funds invested in accounts receivable is 9 percent, and the firms
income tax rate is 40 percent.
14
. What are the days sales outstanding (DSO) before and after the change of credit policy?
A. 27.0 days and 22.5 days, respectively
C. 22.5 days and 21.5 days, respectively
B. 22.5 days and 27.0 days, respectively D. 21.5 days and 22.5 days respectively
15
16
5,000 units
P40,000
P 100
P
4
. The incremental after tax profit from the change in credit terms is
A. P68,493
C. P60,615
B. P65,640
D. P57,615
Inventory management
EOQ
127
Financial Management
(B. Working Capital Management)
A. P19,550
B. P18,750
C. P38,300
D. P62,500
. Paeng Company uses the EOQ model for inventory control. The company has an annual
demand of 50,000 units for part number 6702 and has computed an optimal lot size of 6,250
units. Per-unit carrying costs and stockout costs are P9 and P4, respectively. The following
data have been gathered in an attempt to determine an appropriate safety stock level:
Units Short Because of Excess
Number of Times Short
Demand during the Lead Time Period
in the last 40 Reorder Cycles
100
8
200
10
300
14
400
8
What is the optimal safety stock level?
A. 100 units
C. 200 units
B. 300 units
D. 400 units
22
Trade credit
26
. If a firm is given a trade credit terms of 2/10, net 30, then the cost to the firm failing to take the
discount is:
A. 2.0%.
C. 36.7%
B. 30.0%.
D. 10.0%.
27
Bank loans
Discount loan
28
. You plan to borrow P10,000 from your bank, which offers to lend you the money at a 10
percent nominal, or stated, rate on a one-year loan. What is the effective interest rate if the
loan is a discount loan?
A. 10.00%
C. 12.45%
128
Financial Management
(B. Working Capital Management)
B. 11.11%
D. 14.56%
B. P1,176
34
35
. An invoice of a P100,000 purchase has credit terms of 1/10, n/40. A bank loan for 8 percent
can be arranged at any time. When should the customer pay the invoice?
A. Pay on the 1st.
C. Pay on the 40th
B. Pay on the 10th
D. Pay on the 60th
. The Peninsula Commercial Bank and Island Corporation agreed to the following loan proposal:
Stated interest rate of 10% on a one-year discounted loan; and
15% of the loan as compensating balance on zero-interest current account to be
maintained by Island Corporation with Peninsula Commercial Bank.
The loan requires a net proceeds of P1.5 million. What is the principal amount of loan applied
for as part of the loan agreement?
A. P1,666,667
C. P1,764,706
B. P2,000,000
D. P1,125,000
Add-on
31
. Perlas Company borrowed from a bank an amount of P1,000,000. The bank charged a 12%
stated rate in an add-on arrangement, payable in 12 equal monthly installments.
A. 22.15%
C. 25.05%
B. 24.00%
D. 12.70%
Financing alternative
32
. A company has accounts payable of P5 million with terms of 2% discount within 15 days, net
30 days (2/15 net 30). It can borrow funds from a bank at an annual rate of 12%, or it can
wait until the 30th day when it will receive revenues to cover the payment. If it borrows funds
on the last day of the discount period in order to obtain the discount, its total cost will be
A. P 51,000 less
C. P 75,500 less
B. P100,000 less
D. P 24,500 more
33
D. P1,224
. Every 15 days a company receives P10,000 worth of raw materials from its suppliers. The
credit terms for these purchases are 2/10, net 30, and payment is made on the 30th day
after each delivery. Thus, the company is considering a 1-year bank loan for P9,800 (98% of
the invoice amount). If the effective annual interest rate on this loan is 12%, what will be the
net peso savings over the year by borrowing and then taking the discount on the materials?
A. P3,624
C. P4,800
129
Answer: A
Daily working capital required: 200 x 250
Total working capital needed: 28 days x 50,000
CCC = 18 + 30 20
50,000
1,400,000
28 days
. Answer: B
Cash Conversion Cycle = Ave. collection period + Inventory cycle days Ave. Accounts Payable payment days
Inventory cycle in days
60 days
Average collection period
45 days
Operating cycle
105 days
Deduct Accounts payable payment days
30 days
Cash conversion cycle
75 days
Answer: A
Inventory cycle in days
Average collection period
Operating cycle
Deduct Accounts payable payment days
Cash conversion cycle
75 days
38 days
113 days
30 days
83 days
Answer: D
Inventory conversion period (See #4)
Average collection period (2M/0.1M)
Operating cycle
Less: Ave. Accounts Payable payment days (1.5M/0.5M)
Cash conversion period
50.0 days
20.0 days
70.0 days
30.0 days
40.0 days
Answer: D
Inventory turnover:
Cost of goods sold/Ave. Inventory (8M/1.5M)
Inventory conversion period (360 days/5.33)
5.33x
67.5 days
Answer: A
Annual sales 360 days x 100,000
Inventory turnover 36M/5M
Inventory conversion period 360/7.2
36.0M
7.2x
50.0 days
. Answer: B
Optimal cash conversion size = (9,075,000 x 40 / 0.24)^1/2 = 55,000
Answer: B
OTS: (2 x P3,251,250 x P25 0.09)^1/2 = P42,500
Opportunity cost: P42,500 2 x 0.09
P 1,912.50
Answer: C
Reduction in cash float (2.5 + 1.5)
Additional free cash (4 days x 150 x P500)
Annual savings (P300,000 x 0.07)
10
Answer: C
Average AR 3,375,000/360 x 30 days
Average investment: 281,250 x 0.60
Carrying cost: 168,750 x 0.12
4.0 days
P300,000
P 21,000
281,250
168,750
20,250
11
12
13
14
15
16
Answer: B
DSO = (.4 x 10) + (.60 x 45)
Average AR: 900,000/360x31 days
31 days
P77,500
Answer: D
Credit sale = 40,500,000 x 80% =
Increased credit sales: 32,400,000 x 1.2 =
New Average AR 38,880,000/360 x 40 =
Old Average AR 32,400,000/360 x 30 =
Increase in Average AR
32,400,000
38,880,000
4,320,000
2,700,000
1,620,000
Answer: C
Change in average accounts receivables:
Planned: 2,200,000/360x30
Present: 2,500,000/360x45
Decrease in AR balance
Variable cost ratio
Decrease in investment in AR
183,333
312,500
129,667
75%
96,875
Answer: A
Days sales outstanding
Old policy: (.4 x 15) + (.3 x 30) + (.3 x 40)
New policy (.5 x 10) + (.25 x 30) + (.25 x 40)
Answer: A
Average receivable
New policy: 2.6M/360 x 22.5
Old policy: 2.0M/360 x 27
Incremental Accounts Receivable
Incremental carrying cost on receivable 12,500 x 0.75 x 0.09
Answer: A
Incremental sales
Variable cost (.75 x 600,000)
Additional bad debts (600,000 x 2%)
Additional carrying cost
Additional discounts (2,600,000 x .5 x 03) (2,000,000 x .4 x .02)
Before tax increase in income
Less tax
Incremental income
27.0 days
22.5 days
162,500
150,000
12,500
843.75
600,000
( 450,000)
( 12,000)
(
844)
( 23,000)
114,156
45,663
68,493
17
Answer: B
EOQ = (2 x 32,000 x 20 0.8)^1/2 = 4,000 bags
18
Answer: B
Number of orders made 40,000/100
Annual requirement 400 x 5,000
400
2,000,000
Answer: C
Investment in 1 package (20 x P300)
Required annual return: P6,000 x 0.2
P6,000
P1,200
19
20
21
Answer: C
Average inventory units
Less safety units
Average inventory based on EOQ
Order size 7,000 x 2
12,000
5,000
7,000
14,000
Answer: D
. Answer: B
The optimal safety stock level represents the level that gives the lowest sum of stock out costs and additional
carrying costs. Based on the computation below, the lowest combined costs is P3,340, corresponding to 300-unit
level
First compute the stockout costs based on given probability of demand. Starting with 100-unit level as safety stock, if
the additional demand is 200, the company has stockout of 100 units.
100: (100 x 32* x 0.25) + (200 x 32 x 0.35) + (300 x 32 x 0.20) + (100 x 9) 4,960
200: (100 x 32 x 0.35) + (200 x 32 x 0.20) + (200 x 9)
4,200
300: (100 x 31 x 0.20) + (300 x 9)
3,340
400: (400 x 9)
3,600
stockout per unit x 8 orders per year.
23
24
25
Answer: A
Ordering costs 4 x P200
Carrying costs (50,000 2 x 0.75
Total
800
18,750
19,550
Answer: C
Savings in Expenses/additional Investment in Inventory = Maximum Interest Rate
70,000 / (1,800,000 1,000,000) = 8.75%
Answer: C
Number of units to be purchased in advance: 90,000 7,500
Average investments in working capital: 82,500 x 0.5* x P25
Opportunity cost 1,031,250 x 0.12
*The average investment is one-half (82,500 + 0) 2
82,500
1,031,250
123,750
26
27
. Answer: B
With credit terms of 2/10, n/60 one must pay on the 10th day choosing to finance the net payment (invoice price minus
the cash discount) at the rate of 2 percent for 50 days, paying the loan on the 60th day. The annualized rate of foregoing
the discount is 14.9 percent.
Answer: C
k = (2 98) x (360 20 = 36.7%
The solution assumes that the company foregoes the discount only once during the year.
29
30
31
32
33
Answer: B
k = 10 (100 10) = 11.11%
Answer: C
Principal
Less: Discount 200,000 x 0.15 x 90/360
Compensating balance
Net proceeds
Effective rate: (7,500/172,500) x 360/90
Answer: B
Interest expense 1M x 0.12
Less interest income on additional CA balance (200,000 x 0.03)
Net interest cost
Effective interest rate 114,000/(1,000,000 200,000)
Answer: A
Interest for 1 year 1M x 12%
Average Principal: [1M + (1M/12)] 2
Estimated effective rate 120,000/541,667
Alternative solution for approximate effective rate:
(2 x No. of payments x Interest) [(1 + No. of payments) x Principal]
(2 x 12 x P120,000) (13 x P1M) = 22.15%
200,000
( 7,500)
( 20,000)
172,500
17.4%
120,000
6,000
114,000
14.25%
Answer: C
Discount 5M x 0.02
Interest (5M x 0.98 x 0.12) x 15/360 =
Savings =
120,000
541,667
22.15%
100,000
24,500
75,500
Answer: A
Purchase discount 10,000 x 0.02 x 200 purchases
Interest on borrowed money 9,800 x 0.12
Savings
Number of purchases: 360 days/15-day interval
4,800
1,176
3,624
200
34
. Answer: B
The cost of discounts missed is 12.3% which is more than the 8 percent that the bank charges. The company should
borrow on the 10th, pay the invoice, and finance at 8% for the next 30 days (pay off the bank on the 40th).
Cost of foregoing discount: (1 99) x (360 30) = 12.31%
35
Answer; B
Net proceeds in pesos
Divided by net proceeds percentage 1.00 0.1 0.15
Principal amount
P1,500,000
0.75
P2,000,000