MANAGEMENT ACCOUNTING PART 2

RESPONSIBILITY ACCOUNTING

The following data from Division X of Camila Aguas were gathered:

Costs Budget Actual
Sales P 480,000.00 P 470,000.00
Variable COGS 180,000.00 187,000.00
Fixed Manufacturing Cost 40,000.00 46,500.00
Variable Selling 38,000.00 30,000.00
Fixed Admin 20,000.00 22,000.00
Fixed Selling 50,000.00 53,000.00
Net Income P ??? P ???

1. If the budget was prepared based on 2,000 units, and the actual units happen to be equal with the plan, what
happens to the overall performance of Division X? ____________________
2. If the budget was prepared based on 2,000 units, and the actual units is 80% of the plan, what happens to the
overall performance of Division X? ____________________
3. If the budget was prepared based on 2,000 units, and the actual units is 90% of the plan, what happens to the
overall performance of Division X? ____________________
4. If the budget was prepared based on 2,000 units, and the actual units is 10% higher than the plan, what
happens to the overall performance of Division X is ____________________

The following information pertains to Killer Bride's Gold Division for the current year.

Sales P350,000
Variable cost 250,000
Traceable fixed cost 50,000
Average invested capital 80,000
Cost of goods sold 10%
Cost of capital 10%
Target return 12%

5. What was Gold’s return on investment? _________________

6. What was Gold’s residual income? _________________

Cassie Division of KG, Inc. had the following operation result in 2019:

Sales: P12,000,000
Profit Margin: 20%
Assets P15,000,000

The Division is considering a P2,000,000 investment in a new project. The estimated ROI for all its
operations would be 15% with the new investment. The weighted average cost of capital is 15%

7. How much net income or net loss is the new project expected to contribute? __________________
8. If the manager of the division is evaluated on ROI alone, will she invest on the new project? Why?
_______________________________
9. What would be the residual income for all its operations? _______________________

Marga Division of KG, Inc. had the following operation result in 2019:

Sales: P12,500,000
Profit Margin: 25%
Assets P10,000,000

The Division is considering a P4,000,000 investment in a new project. The estimated ROI for all its
operations would be 20% with the new investment. The weighted average cost of capital is 15%

10. How much net income or net loss is the new project expected to contribute? __________________
11. If the manager of the division is evaluated on ROI alone, will she invest on the new project? Why?
_______________________________
12. What would be the residual income for the new project alone? _______________________

If the investment turnover increased by 140% and ROS decreased by 25%, the ROI would increase/decrease
by
13. ___________________________
 If Division C has a 10% return on sales, income of P 5,000 and an investment turnover of 4 times,
divisional investment is
14. ___________________________

15. UrProf Food Hauz has the following results for the year:

Revenues P900,000
Variable expenses 270,000
Fixed expenses 350,000

The total divisional assets are P1,500,000 and the company's target rate of return is 12 percent, and the
cost of capital is 10%, if sales increased to P1,000,000, the residual income for UrProf is ________________

The following information is available about the status and operations of Jay Arr Company, which has a
required ROI of 15% and discount rate of 12%:

Division Division
A B
------------- --------------
Divisional investment P 500,000 P1,250,000
Divisional profit P 350,000 P 625,000
Variable cost P 500,000 P3,500,000
Divisional sales P1,500,000 P5,500,000

16. Division A could increase its sales by P300,000 by increasing its investment by P300,000. Compute its ROI.
_____________________
17. Division A could increase its sales by P150,000 by increasing its investment by P400,000. Compute its total
residual income. _____________________
18. Division B could reduce its investment so that its asset turnover increased by two, while holding total sales
constant. Compute its residual income. _____________________
19. Division B could reduce its investment so that its asset turnover increased by two, while total sales increased
by 10%.. Compute its ROI. _____________________
20. Division C is being considered to be added. This would require additional investment of P750,000. Upon
addition of this new division, the ROI for all the company’s operations shall become 40%. What is the income
or loss associated with the new investment? ________________________
21. If the manager of the division is evaluated on ROI alone, will the company invest on the new project? Why?
_______________________________

Mabini Trading operates a retail store in North, East and West facilities. The following information
relates to the East facility:
• The store sold 90,000 units at P20.00 each, after having purchased the units from various suppliers for P9.
East’s salespeople are paid a 20% commission based on gross sales pesos.
• East’s sales manager oversees the placement of local advertising contracts, which totaled P50,000 for the year
plus 10% of the gross sales price. Local property taxes amounted to P15,000.
• The sales manager’s P40,000 salary is set by East’s store manager. In contrast, the store manager’s P108,000
salary is determined by PUP’s vice president. The two store supervisors gets P25,000 each.
• East incurred P12,000 of other noncontrollable costs along with P15,000 of income tax expense.
• Nontraceable (common) corporate overhead totaled P48,000.

Mabini’s corporate headquarters is located in Sta. Mesa, and the company uses responsibility accounting
to evaluate performance.

22. The segment contribution margin is _____________________

23. Compute for the income that will be used to evaluate East’s store manager __________________
24. Compute for the income that will be used to evaluate East facility __________________

Mr. Sy is the general manager of the XXX Division, and his performance is measured using the residual
income method. Mr. Sy is reviewing the following forecasts to his division for the next year:
Category Amounts
Working Capital P 1,800,000
Revenue 30,000,000
Plant and Equipment 17,200,000

25. If the imputed interest charge is 15% and Mr. Sy wants to achieve a residual income of P2,000,000 what will
costs (total expenses) have to be in order to achieve the targeted residual income? ________________
 Kikkoman Corporation operates two stores: A1 and B2. The following information relates to B2:
Sales revenue P 100,000
Variable operating expenses 45,000
Fixed expenses:
Traceable to B2 and controllable by B2 17,500
Traceable to B2 and controllable by others 12,500
26. If the common costs of P 10,000 are divided equally between the 2 stores, Store B2’s segment profit margin is:
_______________________

The Avengers Branch of Shield Company presents the following July information for assessment:
Sales P2,400,000
Current Assets 560,000
Noncurrent Assets 720,000
Current Liabilities 280,000
Noncurrent Liabilities 350,000

27. The Avengers Branch's target ROI for the month is set by the head office at 12% and the expenses for July are
P2,144,000, then what is the, Return on Investment? ______________________
28. If residual income for July is P64,000 then what is the profit margin if the target rate of return is 15%?
__________

The Valve Division of Industrial Company produces a small valve that is used by various companies as a
component part in their products. Industrial Company operates its divisions as autonomous units, giving its
divisional manager great discretion in pricing and other decisions. Each division is expected to generate a rate of
return of at least 14 percent on its operating assets. The Valve Division has average operating assets of P700,000.
The valves are sold for P5 each. Variable costs are P3 per valve, and fixed costs total P462,000 per year. The
Division has a capacity of 300,000 units.
29. How many valves must the Valve Division sell each year to generate the desired rate of return on its assets?
________________________

Matipid Division of Expenditures Company expects the following results for 2017:

Unit sales 70,000

Unit selling price P10
Unit variable cost P4
Total fixed costs P300,000
Total investment P500,000

The minimum required ROI is 15 percent, and divisions are evaluated on residual income. A foreign
customer has approached Matipid’s manager with an offer to buy 10,000 units at P7 each. If Matipid accepts the
order, it would not lose any of the 70,000 units at the regular price. Accepting the order would increase fixed costs
by P10,000 and investment by P40,000.

30. What is the minimum price that Matipid could accept for the order and still maintain its expected residual
income? _____________________

TRANSFER PRICING AND PRICING DECISION

PROBLEMS

1. The Selling Division’s unit sales price is P20 and its unit variable cost is P8. Its capacity is 10,000 units. Fixed costs per
unit are P4. Current outside sales is 10,000 units. What is the minimum transfer price that the Selling Division would
be willing to accept if 3,000 units will be sold to the Purchasing Division? Assume that the Purchasing Division can
buy the same from outside market at P18.50. _____________________

2. The Selling Division’s unit sales price is P20 and its unit variable cost is P8. Its capacity is 10,000 units. Fixed costs per
unit are P4. Current outside sales are 7,000 units. What is the Selling Division’s opportunity cost per unit from selling
3,000 units to the Purchasing Division? Assume that the Purchasing Division can buy the same from outside market
at P18.50 ______________________

3. The Selling Division’s unit sales price is P20 and its unit variable cost is P8. Its capacity is 10,000 units. Fixed costs per
unit are P4. Current outside sales is 7,500 units. What is the minimum unit transfer price that the Selling Division
would be willing to accept if 4,000 units will be sold to the Purchasing Division? Assume that the Purchasing
Division can buy the same from outside market at P18.50. _____________________

4. The Selling Division’s unit sales price is P20 and its unit variable cost is P10. Its capacity is 10,000 units. Fixed costs
per unit are P4. Current outside sales is 7,500 units. What is the maximum transfer price that the Purchasing Division
would be willing to accept if 4,000 units will be sold to the Purchasing Division? Assume that the Purchasing
 Division can buy the same from outside market at P18.50 and that a cost of P1 per unit will be saved from the
transfer. _____________________

5. The Selling Division’s unit sales price is P20 and its unit variable cost is P10. Its capacity is 10,000 units. Fixed costs
per unit are P4. Current outside sales is 10,000 units. What is the maximum transfer price that the Purchasing
Division would be willing to accept if 4,000 units will be sold to the Purchasing Division? Assume that the
Purchasing Division can buy the same from outside market at P18.50. _____________________

6. The Selling Division’s unit sales price is P19 and its unit variable cost is P10. Its capacity is 10,000 units. Fixed costs
per unit are P4. Current outside sales is 10,000 units. What is the maximum transfer price that the Purchasing
Division would be willing to accept if 4,000 units will be sold to the Purchasing Division? Assume that the
Purchasing Division can buy the same from outside market at P18.50 and that a cost of P1 per unit will be saved from
the transfer. _____________________

The Lyn Division of Rosal Homes Inc. produces and sells lumber that can be sold to outside customers or
within the company to the Mel Division. The following data have been gathered for the coming period:
Lyn Division:
Capacity 100,000 board feet
Price per board foot P4.00
Variable production cost per board foot P2.00
Variable selling cost per board foot P0.70
Mel Division:
Board feet needed 40,000
Outside price paid per board foot P3.50

If the Lyn Division sells to the Mel Division, P0.40 per board foot can be saved in shipping costs.

7. If current outside sales are 50,000 board feet, what is the minimum transfer price that the Lyn Division could accept?
__________________
8. If current outside sales are 70,000 board feet, what is the minimum transfer price that the Lyn Division could accept?
__________________
9. If Lyn Division has sufficient excess capacity to fulfill the Mel Division’s needs, what will be the effect on the
company’s overall contribution margin? ___________________
10. If Lyn Division has sufficient excess capacity to fulfill the Mel Division’s needs, what will be the effect on the
company’s overall contribution margin if the transfer price negotiated is P2.40? ___________________
11. If Lyn Division has sufficient excess capacity to fulfill the Mel Division’s needs, what will be the effect on the profit of
Mel Division if the transfer price negotiated is P2.40? ___________________
12. If Lyn Division has sufficient excess capacity to fulfill the Mel Division’s needs, what will be the effect on the profit of
the company as a whole if the transfer price of P2.40 is change to P2.70? ___________________
13. If Lyn Division is operating at capacity, what is the effect on the company’s overall contribution margin?
___________________

Tuttle Motorcycles Inc. manufactures and sells high-priced motorcycles. The Engine Division produces and sells
engines to other motorcycle companies and internally to the Production Division. It has been decided that the Engine
Division will sell 30,000 units to the Production Division. The Engine Division, currently operating at capacity, has a unit
sales price of P1,800 and unit variable costs and fixed costs of P700 and P500, respectively. The Production Division is
currently paying P1,600 per unit to an outside supplier. P180 per unit can be saved on internal sales from reduced selling
expenses.

14. What is the minimum transfer price that the Engine Division should accept? ______________
15. What is the increase/decrease in overall company profits if this transfer takes place? ______________
16. If Engine Division has enough excess capacity to provide the requirement of Production Division, what is the
minimum transfer price that the Engine Division should accept? ______________
17. What is the maximum transfer price that the Production Division would be willing to accept? ______________

The Dairy Division of Famous Foods, Inc. produces and sells milk to outside customers. The operation has the
capacity to produce 150,000 gallons of milk a year. Last year’s operating results were as follows:

Sales (100,000 gallons) P 300,000

Variable Cost 175,000
Contribution Margin 125,000
Fixed Cost 65,000
Net income 60,000

18. Assume the Yogurt Division wants to purchase 30,000 gallons of milk from the Dairy Division. The minimum
transfer price that Dairy Division’s is willing to accept _________________
19. Assume the Dairy Division is operating at capacity. If the Yogurt Division wants to purchase 30,000 gallons of milk
from the Dairy Division, what is the minimum price that will allow the Dairy Division to maintain its current net
income? __________
20. Based on #19, if the transfer would take place, what will the effect on the profit of Dairy Division?
____________________
21. Based on #19, if the transfer would take place, what will the effect on the profit of the company as a whole?
____________________

PRICING DECISION

Barquilla, Inc., which manufactures various lines of computer equipment, is planning to introduce a new
line of laptops. Current plans call for the production and sale of 1,000 units, with estimated production costs as
follows:

Variable costs:
Direct Materials P200,000
Direct Labor 120,000
Manufacturing overhead 80,000
Selling and administrative 100,000
Total variable costs P 500,000
Fixed costs:
Manufacturing overhead P300,000
Selling and administrative 100,000
Total fixed costs 400,000
Total costs P900,000

The average amount of capital invested in the laptop product line is P500,000 and Barquilla's target return
on investment is 20%.

1. What unit price must Barquilla charge if the company uses cost-plus pricing based on total cost?
2. If Barquiilla uses cost-plus pricing based on absorption cost, the markup percentage the company must use would
be (2 decimal places)_______________________
3. If Barquilla uses cost-plus pricing based on variable cost, the markup percentage the company must use would be
(2 decimal places)_______________________
4. What is the mark up if the basis is variable production cost?
5. What is the mark up if the basis is full production cost?
6. What is the mark up if the basis is prime cost?

The following data pertain to Romina Foods Enterprises:

Variable manufacturing cost P60

Variable selling and administrative cost 20
Applied fixed manufacturing cost 40
Allocated fixed selling and administrative cost 15

7. What price will the company charge if the firm uses cost-plus pricing based on variable cost and a markup
percentage of 130%? _________________
8. What price will the company charge if the company targets a return equal to 80% of variable manufacturing cost?
_________________
9. What price will the company charge if the firm uses cost-plus pricing based on absorption manufacturing cost
and a markup percentage of 120%? _________________
10. What price will the company charge if the company targets a return equal to 50% of full production cost?
_________________

DaHec Company manufactures office equipment and is ready to introduce a new line of portable copiers.
The following copier data are available:

Variable manufacturing cost P160

Applied fixed manufacturing cost 80
Variable selling and administrative cost 40
Allocated fixed selling and administrative cost 50

11. What price will the company charge if the firm uses cost-plus pricing based on variable manufacturing cost and a
markup percentage of 120%? ___________________
12. What price will the company charge if the firm uses cost-plus pricing based on total variable cost and a markup
percentage of 110%? ____________________
13. What price will the company charge if the firm uses cost-plus pricing based on absorption cost and a markup
percentage of 140%? _____________________
 Athens Corporation manufactures Product A, which is used in the production of mountain bikes. Per-
unit information about Product A follows.

Prevailing market price P90

Direct materials 40
Direct labor 16
Manufacturing overhead 12
Selling and administrative expenses 7

Athens has traditionally used a 40% markup on total cost to arrive at a reasonable selling price. The
company, though, has noticed a sizable drop in sales volume during the last few quarters, which it attributes to
new entrants in the marketplace.

14. Based on the markup, the selling price of Product A would be _________________
15. If management desired to meet the prevailing market price and maintain the current rate of profit on sales,
what must happen to the company's total manufacturing costs (increase or decrease)? By how much?
____________________

DIFFERENTIAL COST ANALYSIS

Make or Buy

Jam Foods Corp is known for selling a great tasting yet very affordable siomai in Manila. Information on selling
price and related costs of one complete order is shown below. Fixed cost is computed using the normal operations of
3,000 orders (4pcs per order).

Selling price per order P 25.00

Variable cost per order
Direct materials P 4.00
Direct Labor 4.00
Variable Overhead 2.00
Fixed cost allocated to products per order
Supervisory salaries P 3.00
Other fixed cost 3.00

1. If Erwin has offered to supply siomai for P3 per piece, on normal operations, should Jam make or buy siomai?

Suppose that Erwin has offered to supply siomai for P3 per piece and that P2.50 of the total fixed costs could be
eliminated.

2. Should Jam make or buy siomai?

3. Determine the indifference point.
4. If Jam plans to sell 1,800 orders, should the company make or buy siomai?

Accept or Reject:

Jam Foods Corp is known for producing and selling a great tasting yet very affordable siomai. Information on
selling price and cost per unit at a normal capacity of 20,000 pieces is as follows:

Selling Price P 6.25

Less, Variable Cost 2.50
Contribution Margin P 3.75
Less, Fixed Cost 1.50
Net Profit P 2.25

Ruby House of Dumplings offers to buy 5,000 pieces at P3.65. Also, an extra shipping cost of P0.15 per unit will be
incurred if the company will accept the special order.

5. If the business is presently very slow, should Jam accept or reject the order?
6. If Jam has more businesses than it can handle, should the special order be accepted?
7. If present production is 16,500 pieces, should the Jam accept or reject the special order?
Drop/Eliminate, Retain or Add:

Jam Foods Corp has three product lines. Results of the 4th quarter are presented below:

Shrimp Pork Beef Total

Units sold 800 4,000 4,200 9,000
Revenue P20,000.00 P100,000.00 P105,000.00 P225,000.00
Variable departmental costs 12,000.00 40,000.00 42,000.00 94,000.00
Direct fixed costs 5,000.00 15,000.00 15,000.00 35,000.00
Allocated fixed costs 8,000.00 12,000.00 12,000.00 32,000.00
Net Income (Loss) (P5,000.00) P33,000.00 P36,000.00 P64,000.00

Demands of individual products are not affected by changes in other product lines.

8. Will Jam retain or drop Shrimp Siomai?

9. What will be the net income or loss of Jam if Shrimp is dropped?

Condensed monthly operating income data for Ohio, Inc. for May follows:

Urban Store Suburban Store Total

Sales ₱80,000 ₱120,000 ₱200,000
Variable costs 32,000 84,000 116,000
Contribution margin ₱48,000 ₱ 36,000 ₱ 84,000
Direct fixed costs 20,000 40,000 60,000
Store segment margin ₱28,000 (₱4,000) ₱ 24,000
Common fixed cost 4,000 6,000 10,000
Operating income ₱24,000 (₱10,000) ₱ 14,000

Additional information regarding Ohio's operations follows:

• One-fourth of each store's direct fixed costs would continue if either store were closed.
• Ohio allocates common fixed costs to each store on the basis of sales pesos.
• Management estimates that closing the Suburban Store would result in a 10% decrease in the Urban Store's
sales, while closing the Urban Store would not affect the Suburban Store's sales.
• The operating results for May are representative of all months.

10. A decision by Ohio to close the Suburban Store would result in a monthly increase (decrease) in Ohio's
operating income of ________________

A merchandising company has two departments, H and M. A recent monthly income statement for the company
follows:

Total Department H Department M

Sales ₱4,000,000 ₱3,000,000 ₱1,000,000
Less: Variable cost and expenses 1,300,000 900,000 400,000
Contribution margin ₱2,700,000 ₱2,100,000 ₱ 600,000
Less: Fixed cost and expenses 2,200,000 1,400,000 800,000
Net operating income/(loss) ₱ 500,000 ₱ 700,000 (₱200,000)

A study indicates that ₱340,000 of the fixed expenses being charged to Department M are sunk costs or allocated
costs that will continue even if M is dropped. In addition, the elimination of Department M will result to a 10% increase
in the sales of Department H.
11. If Department M is dropped, what will be the effect of the net operating income of the company as a whole?
____________________

Shut down or Continue operations:

ABC Company is contemplating to temporarily stop operating for the next four months since demand declines
below the breakeven point. The company has a normal operating fixed cost of P50,000 per month and if they shut down,
they could eliminate P20,000 fixed cost per month. However, they would incur additional costs for insurance and security
guards for the entire shut down period of P25,000. They estimated that the restarting cost will be P20,000. At present, they
have a selling price of P50 per unit and a variable cost of P30. For the next four months, they will be forced to reduce their
selling price to 80%. Based on these facts, determine the following:

12. Shut down costs ____________________________

13. Shut down savings ____________________________
14. Shut down point ____________________________
15. If the monthly sales will temporarily drop to only 1,000 units, will you recommend to shut down or continue
operations? ____________________________

Sell as is or Process Further:

Vicky manufactures A and B from a joint process (cost = P80,000). Five thousand pounds of A can be sold at split-
off for P20 per pound or processed further at an additional cost of P20,000 and then sold for P25. Ten thousand pounds of
B can be sold at split-off for P15 per pound or processed further at an additional cost of P20,000 and later sold for P16.

If Vicky decides to process B beyond the split-off point, the change in operating income will be

Profit maximization – by utilizing limited or scarce resources:

Smith Manufacturing has 6,000 labor hours available for producing X and Y. Consider the following information:
Product X Product Y
Selling price per unit P10.00 P20.00
Variable cost per unit 5.00 14.00
Contribution margin per unit P5.00 P6.00

Required labor time per unit (hours) 2 3

Replace or retain Equipment:

CAPITAL BUDGETING

To arrive at a long term decision, a firm needs to identify the following:

1.
a.
b.
c.

2.

3.

Methods

Those that do not consider time value of money

1. Payback Period 2. Accounting Rate of Return

Those that consider time value of money

1. Discounted payback period 4. Modified internal rate of return
2. Net present value 5. Profitability Index
3. Internal rate of return
Payback Period

Even Cash Flow

Aquino plans to purchase a piece of equipment which amounts to P210,000 in accordance with an
investment proposal from a member of his staff. If the equipment is bought, it is expected to generate an annual
cash inflow of P55,000. A four year payback period is acceptable to Aquino.
Year Cash Inflow
1 55,000
2 55,000
3 55,000
4 55,000
5 55,000
6 55,000

Uneven Cash Flow

Aquino plans to purchase a piece of equipment which amounts to P210,000 in accordance with an
investment proposal from a member of his staff. If the equipment is bought, it is expected to generate cash inflow
as shown below. A four year payback period is acceptable to Aquino.
Year Cash Inflow
1 P30,000
2 40,000
3 50,000
4 60,000
5 180,000
6 290,000
Accounting Rate of Return

Tina’s initial investment on Project A is P100,000. Its estimated useful life is 20 years. Cash inflow per year
is P17,500. What is the ARR?

Discounted Payback Period

Mr. Hopia plans to put up a small stall in front of his house. The overall cost of the construction is
P180,000. The stall is expected to generate cash inflow for 7 years as shown below. A four-year discounted
payback period is acceptable to Mr. Hopia. (WACC is 12%)

Year Annual Cash Returns PVf Discounted amount

1 50,000
2 50,000
3 50,000
4 50,000
5 50,000
6 50,000
7 50,000

Year Annual Cash Returns PVf Discounted amount

1 40,000
2 50,000
3 60,000
4 80,000
5 80,000
6 70,000
7 60,000
Net Present Value/ Profitability Index

Kim Corp invested P25,000 in a 4-year project. Kim’s cost of capital is 8%. Additional bits of information
on the project are as follows:

After tax Cash Inflow

Year of P1 PVf Present Value
1 10,000
2 15,000
3 18,000
4 16,000

Internal Rate of Return

Assume the following information from Kam’s Korner:
Initial Investment P150,000
Estimated life 10 years
Annual cash inflows P20,000
Cost of capital 12.0%

Modified Internal Rate of Return

A 5-year project with an initial outlay of P18,000 an d a cost of capital of 14% will produce an annual cash
return of P5,600. The IRR of the project is 16.80%.

Mutually exclusive projects

Assume the following cash returns for Projects A and B with the cost of capital of 10%
Year Project A Project B
0 (P2,000) (P2,000)
1 200 900
2 400 700
3 600 600
4 700 400
5 900 200

Capital Rationing (combination of acceptable projects)

Projects Initial Present

Outlay Value
A 90,000 112,500
B 80,000 90,000
C 120,000 180,000
D 80,000 80,000
E 40,000 30,000
F 50,000 90,000

Other Problems:

1. Rabbit Company faces a marginal tax rate of 35%. One project that is currently under evaluation has a cash
flow in the fourth year of its life that has a present value of ₱10,000 (after-tax). Rabbit Company assumes
that all cash flows occur at the end of the year and the company uses 11% as its discount rate. What is the
pre-tax amount of the cash flow in year 4? (Note: Round to the nearest peso.)

2. LBC Shipment Company is considering the purchase of a new ocean-going vessel that could potentially
reduce labor costs of its operation by a considerable margin. The new ship would cost ₱500,000 and would
be fully depreciated by the straight-line method over ten years. At the end of ten years, the ship will have no
value and will be sunk in some already polluted harbor. The LBC Shipment Company’s cost of capital is
12%, and its marginal tax rate is 40%. What is the present value of the depreciation tax benefit of the new
ship? (Note: Round to the nearest peso.)

3. M2 Company recently sold a used machine for ₱40,000. The machine had a book value of ₱60,000 at the time
of the sale. What is the after-tax cash flow from the sale, assuming the company’s marginal tax rate is 20%?
4. M2 Company recently sold a used machine for ₱70,000. The machine had a book value of ₱60,000 at the time
of the sale. What is the after-tax cash flow from the sale, assuming the company’s marginal tax rate is 20%?

5. Toyota Company is considering an investment in a machine that would reduce annual labor costs by
₱30,000. The machine has an expected life of ten years with no salvage value. The machine would be
depreciated according to the straight-line method over its useful life. The company’s marginal tax rate is
30%. Assume the company pays ₱250,000 for the machine. What is the expected internal rate of return on the
machine?

6. A project under consideration by the Browny Corporation would require a working capital investment of
₱200,000. The working capital would be liquidated at the end of the project’s ten-year life. If Browny
Corporation has an after-tax cost of capital of 10% and a marginal tax rate of 30%, what is the present value
of the working capital cash flow expected to be received in year 10?

7. Beams Company is considering two alternative ways to depreciate a proposed investment. The investment
has an initial cost of ₱100,000 and an expected five-year life. The two alternative depreciation schedules
follow:

Method 1 Method 2
Year 1 depreciation ₱20,000 ₱40,000
Year 2 depreciation 20,000 30,000
Year 3 depreciation 20,000 20,000
Year 4 depreciation 20,000 10,000
Year 5 depreciation 20,000 0

Assuming that the company faces a marginal tax rate of 40% and has a cost of capital of 10%,
what is the difference between the two methods in the present value of the depreciation tax benefit?
____________________

8. Small Sisters, Inc. is considering an investment in a computer that is capable of producing various images
that are useful in the production of commercial art. The computer would cost ₱20,000 and have an
expected life of eight years. The computer is expected to generate additional annual net cash receipts
(before-tax) of ₱6,000 per year. The computer will be depreciated according to the straight-line method and
the firm’s marginal tax rate is 25%. What is the after-tax payback period for the computer project?
______________________

WORKING CAPITAL MANAGEMENT

WORKING CAPITAL AND CASH MANAGEMENT

In its 2017 annual report, Luzvimin Corporation reported that it had revenues of P18 billion, cost of
goods sold of P16.8 billion, accounts receivable of P2.4 billion, inventory of P2.1 billion and accounts payable of
P1.25 billion. Total purchases for the year was P11.25 billion.
1. Determine the cash conversion cycle.

The balance sheet of Olive Industries for December 31, 2016 contains the following. The amounts
also pertain to the average for the year.

ASSETS LIABILITIES AND SHAREHOLDERS EQUITY

Cash 10,000 Accounts Payable 56,250
Marketable Securities 80,000 Notes Payable (Short Term) 17,000
Accounts Receivable 60,000 Other Current Liabilities 52,000
Inventories 100,000 Long Term Debt 82,000
Plant and Equipment 220,000 Preferred Stock 50,000
Less: Depreciation 64,000 Common Stock 49,000
Net Plant and Equipment 156,000 Paid in Surplus 39,750
Retained Earnings 60,000
Total Assets 406,000 Total Liabilities and Shareholders' Equity 406,000

Sales for the year amounted to P720,000. Mark up on cost is 60%.

2. What is the working capital?

3. Determine the cash conversion cycle.
 USANA Company has a permanent funding requirement of P300,000 in operating assets and
seasonal funding requirements that vary between P0 and P800,000 and average P250,000. USANA can borrow
short-term funds at 6.5% and long-term funds at 9%, and it can earn 5% on the investment of any surplus
balances.
4. What is the total cost of an aggressive strategy for seasonal funding?
5. What is the total cost of conservative strategy for seasonal funding?
Alivia corporation has a permanent funding requirement of P250,000 in operating assets and seasonal
funding requirements that vary up to P1,100,000 and average P180,000. Alivia can borrow short-term funds at 7%
and long-term funds at 9%, and it can earn 6% on the investment of any surplus balances.
6. What is the annual cost of an aggressive strategy for seasonal funding?
7. What is the annual cost of a conservative strategy for seasonal funding?

Roxas company has a permanent funding requirement of P400,000 in operating assets and seasonal
funding requirements that vary up to P600,000 and average P120,000. Roxas can borrow short-term funds at 6%
and long-term funds at 8%, and it can earn 5% on the investment of any surplus balances.
8. Which funding strategy would be loss costly? What is the net advantage?

GGEM Corporation has an agreement with Security Bank Corp (SBC) to collect P3,000,000 a day in
exchange for a compensating balance of P500,000. The firm, with a significant increase in its customer in the area,
is thinking of cancelling the agreement and dividing the service provided by SBC with China Bank, Inc (CBI).
With this plan, SBC will handle the collection of P2,000,000 with a compensating balance of P800,000. On the other
hand, CBI bank will handle the other P1,000,000 collection in exchange for a compensating balance of P400,000.
With the planned arrangement with the two banks to perform the collection, the firm is expecting to reduce the
collection period by one day. The firm's rate of return is 7%.
9. What is the amount of incremental income or loss if GGEM will pursue the division of service between SBC
and CBI?
It takes CELLSENTIALS several days to receive and deposit collections from customers to its three
banks. Therefore, lockbox system is being considered. The bankers explain that with the system in place, the
expected float time will be reduced. The following shows the packages offered by the banks:
Banks: China Land Metro

Average daily collections P500,000 420,000 350,000

Current float 7 days 8 days 9 days
Expected float if lockbox is availed 5 days 6 days 6 days
Rate of return 10.00% 12.00% 12.00%
Cost of lockbox system P8,000 P24,500 P48,000
Monthly Quarterly Semi-annually

10. How much is the advantage (disadvantage) of the lockbox system offered by China?
11. How much is the advantage or disadvantage of the lockbox system offered by Land?
12. How much is the advantage or disadvantage of the lockbox system offered by Metro?

ABC company is a retail mail order that currently uses a central collection system that requires all
checks to be sent to its headquarters. An average of 6 days is required for mailed checks to be received, 3 days to
process them and 2 days for the checks to clear through its bank. A proposed lockbox system would reduce the
mailing and processing time to 2 days and the check clearing time to 1 day. An entity has an average daily
collection of P150,000.
13. How much would be the increase in the average cash balance if the company adopts the lockbox system?

Assume that the fixed cost of selling marketable securities is P10 per transaction and the interest rate on
marketable securities is 8% per year. The company estimates that it will make cash payments of P12,500,000 per
quarter.
14. Optimal transcaction size
15. Average cash balance
16. the number of times (during the year) the company has to convert marketable securities to cash
17. the total cost of converting marketable securities to cash,
18. the total carrying cost of cash.

RECEIVABLE MANAGEMENT

Assume that your firm is considering relaxing its current credit policy. Currently the firm has annual sales,
all credit, of P16 million and an average collection period of 30 days. The firm is considering a change in credit
terms from the current terms of net 30 to 1/30 net 60. The change is expected to generate additional sales of P2
million. The firm has variable costs of 75% of the selling price. The information provided here, plus additional
information, is summarized in the table below.

New sales (all credit) P18,000,000

Original sales (all credit) P16,000,000
Contribution margin 25%
Percent bad debt losses on new sales 6%
New average collection period 45 days
Original average collection period 30 days
Additional inventory investment P50,000
Pre-tax required rate of return 15%
New percent cash discount 1%
Percent of customers taking the discount 50%

1. If the credit policy change is made, the change in bad debt losses will be:
2. If the credit policy change is made, the change in profit will be:
3. If the credit policy change is made, the additional investment in accounts receivable will be:
4. If the credit policy change is made, the cost of the additional investment in accounts receivable and inventory
will be:
5. If the credit policy change is made, the change in the cost of the cash discount will be:
6. If the credit policy change is made, the net effect will be:

Stop and Chop has an inventory conversion period of 60 days, a receivable conversion period of 35
days, and a payment cycle of 26 days. Sales for the period just ended amounted to P972,000 while cost of sales
amounted to P1,260,000. Credit purchases amounted to P684,000. (Assume 360 days a year.)
7. How much is the investment in accounts receivable?
8. How much is the cash conversion cycle?

The Sales Director of Sweet Bites suggests that certain credit terms be modified. He estimates that sales
will increase by at least 20% and accounts receivable turnover will be reduced to 8 times from the present
turnover of 10 times. Bad debts, now at 1% of sales will increase to 1.5%. Sales before the proposed changes is at
P900,000. Variable cost ratio is 55% and desired rate of return is 20%. Fixed expenses amount to P150,000.
9. How much is the increase in profit from the sales?
10. How much is the cost of marginal investment in accounts receivable?
11. How much is the cost marginal bad debt?

Kisha Company has annual credit sales of P4 million. Its average collection period is 40 days and bad
debts are 5% of sales. The credit and collection manager is considering instituting a stricter collection policy,
whereby bad debts would be reduced to 2% of total sales, and the average collection period would fall to 30 days.
However, sales would also fall by an estimated P500,000 annually. Variable costs are 60% of sales and the cost of
carrying receivables is 12%. (Assume 360 days a year)
12. How much is the decrease in profit from the sales?
13. How much is the savings from marginal investment in accounts receivable?
14. How much is the savings from marginal bad debt?

Chopstop company plans to tighten its credit policy. The projected sales for the coming year are P50M.
The new policy will decrease the average number of days in collection from 75 to 50 days and reduce the ratio of
credit sales to total revenue from 70% to 60%. The company estimates that the projected sales would be 5% less if
the proposed new credit policy were implemented. The firm’s short-term interest cost is 10%. (assume a 360-day
year)
15. How much is the average accounts receivable for the coming year using the present/current credit
policy?
16. How much is the average accounts receivable for the coming year using the proposed change in
credit policy?
17. How much would be the benefit (cost) of implementing this new policy on income before taxes?

GGEM offers branded designer prescription eyeglasses. All sales are currently on credit and with no
cash discount. The firm is considering a 2% cash discount for payment within 10 days. The firm's current average
collection period is 90 days, sales are 700 units per year, selling price is ₱25,000 per unit, variable cost per unit is
₱18,750, and the average cost per unit is ₱21,000. The firm expects that the change in credit terms will result in a
minor increase in sales of 15 units per year, that 75% of the sales will take the discount, and the average collection
period will drop to 72 days. The firm's bad debt expense is expected to become negligible under the proposed
plan. The bad debt expense is currently 0.025% of sales. The firm's required return on equal-risk investments is
20%. (Assume a 360-day year)
18. How much is the cost of the marginal cash discount?
19. How much is the net benefit (cost) of increasing the cash discount?
 Lodi Optical, Inc, offers branded designer prescription eyeglasses. All sales are currently on credit and
with no cash discount. The firm is considering a 2 percent cash discount for payment within 10 days. The firm's
current average collection period is 90 days, sales are 700 units per year, selling price is ₱25,000 per unit, variable
cost per unit is ₱18,750, and the average cost per unit is ₱21,000. The firm expects that the change in credit terms
will result in a minor increase in sales of 15 units per year, that 75 percent of the sales will take the discount, and
the average collection period will drop to 72 days. The firm's bad debt expense is expected to become negligible
under the proposed plan. The bad debt expense is currently 0.025 percent of sales. The firm's required return on
equal-risk investments is 20 percent. (Assume a 360-day year.)
20. What is the marginal investment in accounts receivable under the proposed plan?
21. What is the cost of marginal investment in accounts receivable under the proposed plan?
22. What are the savings of marginal bad debts under the proposed plan?
23. What is the cost of the marginal cash discount?
24. What is the net result of increasing the cash discount?

INVENTORY MANAGEMENT

Barter Corporation had been buying Product A in lots of 1,200 units which represents a four month's
supply. The cost per unit is P100; the order cost is P200 per order; and the annual inventory carrying cost for one
unit is P25. The lead time is 5 days. (Use 360-day year)
1. What is the economic order quantity?
2. Frequency of order
3. Total inventory cost
4. Reorder point
5. Safety stock if the maximum daily usage is 14 units

Neggie Corp has a secret ingredient in its production. This ingredient costs the company P60 each from
the supplier and requires a 6-day lead time. The demand every quarter is 13,680 units. The ordering cost is P12.50
per order. (EOQ is 1200 units)

6. The carrying cost per unit is

7. The desired safety stock if the maximum daily usage is 175 units is
8. The total inventory cost amounts to

The General Chemical Company uses 150,000 gallons of hydrochloric acid per month. The cost of
carrying the chemical in inventory is 50 cents per gallon per year, and the cost of ordering the chemical is P150
per order. The firm uses the chemical at a constant rate throughout the year.
9. The chemical’s economic order quantity is

The General Chemical Company uses 150,000 gallons of hydrochloric acid per month. The cost of
carrying the chemical in inventory is 50 cents per gallon per year, and the cost of ordering the chemical is P150
per order. The firm uses the chemical at a constant rate throughout the year. It takes 18 days to receive an order
once it is placed.
10. The reorder point is

The General Chemical Company uses 150,000 gallons of hydrochloric acid per month. The cost of
carrying the chemical in inventory is 50 cents per gallon per year, and the cost of ordering the chemical is P150
per order. The firm uses the chemical at a constant rate throughout the year. It takes 18 days to receive an order
once it is placed.
11. If the maximum usage is 162,000 gallons per month, the safety stock is

The ReignLyn Tags Company produces a luggage and bag tag product, and has the following information
available concerning its inventory items:

Annual demand - 50,000 units per year

Purchase price - ₱35 per package
Ordering costs - ₱250 per purchase order
Carrying costs - 10% of purchase price plus: ₱4.50

12. What is the economic order quantity?

13. What are the total relevant costs at the economic order quantity?
14. What are the total relevant costs, assuming the quantity ordered equals 1,000 units?

Yana Corp’s monthly material requirement used in production is 4,050 units. This material costs P180 per
unit for a supplier and it requires 5 days lead time from the date of order to date of delivery. The ordering cost is
P120 per order and the carrying cost is 8% of inventory investment per unit. (Use 360 days).
 Determine the following:
15. EOQ
16. Frequency of order
17. Total inventory cost
18. Reorder point
19. Reorder point if maximum daily usage is 150 units
20. Safety stock

RCR Company has a secret ingredient in its production. This ingredient costs the company P60 each from
the supplier and requires 5-day lead time. The ordering cost is P25 per order and the carrying cost per unit is 10%
of purchase price. (EOQ is 2,400 units).

Determine the following:

16. Annual demand
17. Frequency of order
18. Total inventory cost
19. Reorder point
20. Reorder point if maximum daily usage is 1,200 units
21. Safety stock

Viray Company makes bicycles. It produces 800 bicycles a month. It buys the tires for bicycles from a supplier
at a cost of P20 per tire. The company’s inventory carrying cost is estimated to be 15% of cost and the ordering is
P50 per order.
22. Calculate the EOQ.
23. What is the number of orders per year?
24. Compute the average inventory.

The Polly Company wishes to determine the amount of safety stock that it should maintain for Product D
that will result in the lowest cost. The following information is available:

Stock-out cost per occurrence P80

Carrying cost per unit of safety stock P4
Number of purchase orders per year 5

The available options open to Polly are as follows:

Units of Probability of Running

Safety stock out of Safety stock
20 50%
30 40%
40 25%
50 10%
60 5%

25. Determine the number of units of safety stock that will result in the lowest cost.

SHORT TERM FINANCING MANAGEMENT

1. What is the effective annualized cost of foregoing the trade discount on terms 2/10 net 80
2. What is the effective annualized cost of foregoing the trade discount with terms 2/15 net 70

Stanley Shoe Company established a line of credit with a local bank. The maximum amount that can be
borrowed under the terms of the agreement is P100,000 at an annual rate of 12%. A compensating balance
averaging 10% of the amount borrowed is required. Prior to the agreement, the company had no deposit with the
bank. Shortly after signing the agreement, the company needed P50,000 to pay off a note that was due. It
borrowed the P50,000 from the bank by drawing on the line of credit.
3. What is the effective annual cost of credit?

Smith & Smith Enterprises has a line of credit with National Bank that allows the company to borrow up
to P350,000 at an interest rate of 15%. However, the firm must keep a compensating balance of 10% of any amount
borrowed on deposit at the bank. The company does not normally keep a cash balance account with the bank.
4. What is the effective annual cost of credit?

The Azurin Corporation was recently quoted terms on a commercial bank loan of 7% discounted interest
with a 20% compensating balance. The term of the loan is 1 year.
5. The effective cost of borrowing is
 Salguero, Inc. can issue 3-month commercial paper with a face value of P1,000,000 for P980,000. Transaction
costs will be P1,200.
6. The effective annualized percentage cost of the financing, based on a 360-day year, will be:

7. When a company offers credit terms of 2/10, net 30, the annual interest cost, based on a 360-day year, is:

8. If a firm's credit terms require payment within 45 days but allow a discount of 2% if paid within 15 days
(using a 360-day year), the approximate cost or benefit of the trade credit terms is:

9. Tolentino, Inc. buys on terms of 2/10, net 30 days. It does not take discounts, and it typically pays 35 days
after the invoice date. Net purchases amount to P720,000 per year. What is the nominal annual cost of its
non-free trade credit?

10. Assume that the current borrowing rate is at 15%. Which of the following discounts should the firm take?
a. 2/10, net/45
b. 1/15, net/75
c. 3/10, net/80
d. 1/10, net/45

Graveler Mining plans to borrow P100,000 for one year under a line of credit with a stated interest rate of
7.5 percent and a 15 percent compensating balance.

Case A:
If the firm normally keeps a balance of about P10,000 in its checking account and is willing to accept loan
proceeds lesser than P100,000.
11. The loan proceeds would be P______________________
12. The interest to be repaid on the amount borrowed would be P______________________.
13. The effective annual interest rate on the loan is ________%

Case B:
If the fi rm normally keeps almost no money in its checking account. Loan proceeds: P100,000.
12. The interest to be repaid on the amount borrowed would be P______________________.
13. The amount borrowed would be P______________________ .

A company obtained a short-term bank loan of P250,000 at an annual interest rate of 6%. As a condition of
the loan, the company is required to maintain a 20% compensating balance in its checking account. Ordinarily,
the company maintains a balance of P25,000 in its checking account for transactions purposes.
14. What is the effective interest rate of the loan?

Precious Company has a revolving line of credit of P300,000 with a one-year maturity. The terms call for a
6% interest rate and a ½% commitment fee on the unused portion of the credit line. The average loan balance
during the year was P100,000.
15. How much is the annual cost (in pesos) of this financing arrangement?

“Successful men and women keep moving. They make mistakes, but they don’t quit.”