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Working Capital Policy
. Real Company has P8,000,000 in current assets, P3,500,000 of which are considered
permanent current assets. In addition, the firm has P6,000,000 invested in fixed assets. Real
Company wishes to finance all fixed assets and permanent current assets plus half of its
temporary current assets with long-term financing costing 15 percent. Short-term financing
currently costs 10 percent. Real Company's earnings before interest and taxes are
P2,200,000. Income tax rate is 40 percent.

Working Capital Management
A. What was Amore’s total debt in 2002?
B. How much new, long-term debt financing will be needed in 2003?


How much would Real Company's earnings after taxes under this financing plan?


A firm that is in the process of preparing its financial plan for the upcoming year has estimated
the following current assets (in P000,000) for the year.

The KRAM Company had the following data for the current year, 2004:
Sales, 2004
Sales, 2005
Items that vary directly with sales:
Net profit margin
Payout ratio

1. Compute the projected additional financing needed for 2005.
2. Compute the projected additional financing needed for 2005 under each assumption:
A. Payout ratio is 55%

1. How much will the firm’s permanent level of assets be for the coming year?

C. Sales next year is P5,000,000 and the payout ratio is 40%.

3. Compute the maximum temporary financing requirement of the firm.
External Financing Needed
. At year-end 2002, total assets for Amore Inc. were P1.2 million and accounts payable were
P375,000. Sales, which in 2002 were P2.5 million, are expected to increase by 25% in 2003.
Total assets and accounts payable are proportional to sales, and that relationship will be
maintained. Amore typically uses no current liabilities other than accounts payable. Common
stock amounted to P425,000 in 2002, and retained earnings were P295,000. Amore plans to
sell new common stock in the amount of P75,000. The firm’s profit margin on sales is 6
percent, 60 percent of earnings will be retained.
Exercises & Problems



The firm’s fixed assets should remain constant at P40 million. Owner’s equity is forecast to be
P25 million. Working capital policy requires that 50% of maximum current assets be financed
with permanent financing.

2. Compute the permanent financing requirement of the firm.


B. Net profit margin is 10% and payout ratio is 30%



The 2003 sales of Reign Co. amounted to P8 million. The dividend payout ratio is 30%. The
percent of sales in each balance sheet item that varies directly with sales are expected to be
as follows:
Net fixed assets
Accounts payable
Accrued expenses
Net profit rate
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The new production process would allow Samson to decrease it s inventory conversion period to 20 days and to increase its daily production to 1. and the firm generally pays suppliers in 30 days.5 days.500 batteries a day. . A. Assuming a 360-day year.000.500 batteries a day at a cost of P600 per battery for materials and labor. Compute the annual cost of cash based on optimal transaction size Receivables Management 11 . How much additional (external) capital will be required? C. the new process would cause the cost of materials and labor to increase to P700. What is the optimal transaction size for transfer from marketable securities to cash? B. It takes the firm 22 days to convert raw materials into a battery. Samson's management is trying to analyze the effect of a proposed new production process on the working capital investment. a leading producer of automobile batteries. How could management reduce the cash conversion cycle? 8 A firm that has an annual opportunity cost of 12% is contemplating installation of a lockbox system at an annual cost of P90. B. Assuming the change does not affect the receivables collection period (40 days) or the payables deferral period (30 days). Calculate the amount of negotiated financing required to support the firm’s cash conversion cycle. Forty percent of the customers pay on the 10th day and take discounts. A. the other 60 percent pay. reduce processing time by 1. and reduce check clearing time by 1 day. The firms spends P30 million on operating cycle investments each year. How much cash would the lock-box system free up for the company? B.MANAGEMENT ADVISORY SERVICES Working Capital Management A. What will be Syl’s average cash balance? C. A. at a constant rate. Syl Company projects that cash outlays of P45 million will occur uniformly throughout the year. Calculate the firm’s operating cycle B. net 30. Calculate the firm’s cash conversion cycle Exercises & Problems C. What is the maximum amount that Calma would be willing to pay for the lock-box system if it can earn 6 percent on available short-term funds? C. Cash Management 6 . . Page 2 of 9 . on average. Accounts payable are paid approximately 30 days after they arise. What is the length of Samson's cash conversion cycle? B. McPan Company sells on terms of 3/10. By what amount could Samson reduce its working capital financing needs if it was able to stretch its payables deferral period to 35 days? D. If the lock-box system could be arranged at an annual cost of P45. inventories turns over 5 times. On the average. what would be the net gain from instituting the system? 10 . At a steady state in which Samson produces 1. turns out 1. Samson Corporation. If the firm collects P300. The firm’s marketable securities are invested to earn 12 percent.000. Assume 360 days per year.000. Samson allows its customers 40 days in which to pay for the batteries. 40 days after their purchases.800 batteries.000. and accounts receivable are collected in 60 days.000 per day. Suppose that in 2004 sales increased by 25% over 2003 sales. what will be the length of the cash conversion cycle and the working capital financing requirement if the now production process is implemented? 7 . What would happen to capital requirement if Reign can increase its sales by 40% and the payout ratio is increased to 40%? D. The company treasurer estimates that a proposed lock-box system could reduce its collection time by 2 days. and the cost per transaction of converting securities to cash P30. Total sales for the years are P900. what amount of working capital must it finance? A. Abbey Products is concerned about managing cash efficiently. The system is expected to reduce mailing time by 2 days. would you recommend the system? 9 Calma Company uses a continuous billing system that results in average daily receipts of P750. Syl plans to meet its cash requirements by periodically selling marketable securities from its portfolio. However.

Variable costs are 60 percent. Assuming 360 days a year. Tri Company's financial plan for next year. B.000. C. How much is the incremental benefits in form of cost savings that can be achieved from the plan? Exercises & Problems C. last year reported sales of P10. What would be the effect of those changes in net income? Inventory Management 14 . currently has sales of P2. Costs of products and related expenses amount to 40%. Dessa. What would be the incremental cost of carrying receivables? C. and 1 percent of its sales end up as bad debts. A. What would happen to average receivables if McPan toughened up on its collection policy with the result that all no-discount customers paid on the 30th day? B.MANAGEMENT ADVISORY SERVICES A. Should the firm switch to seasonal production? (ignore income taxes) 13 .5 million. 1.000. but its bad debt losses on the incremental sales would be 2. The manager intends to extend the credit term to 45 days which will increase sales to P3. 12 . compute the annual effective cost of giving up the discount on each supplier. 5. Evaluate each supplier separately using your findings in Question A. A. Assuming that the entity continuously foregoes the cash discount. Compute the incremental investment required to finance the increase in receivables if the change is effected. Determine the annual approximate cost of giving up the cash discount from each supplier.shows sales of P72 million and cost of sales of P45 million. B. Determine the EOQ for the component parts.000 and an inventory turnover ratio of 2. What is the average amount of receivables? A. sales will increase by P250. The company is now adopting a just-in-time inventory system.3 million. 10. bad debt losses on the incremental sales would be 3%. Compute the total inventory costs associated with placing orders of 20. The credit terms for each of three suppliers are shown below: Supplier A Supplier B Supplier C Supplier D 2/10 n/55 3/10 n/55 2/15 n/45 2/10 n/30 A. What is the days sales outstanding? Working Capital Management 16 .000 because of additional startups and other inefficiencies. and the cost of carrying receivables. Assuming that the firm needs short-term financing. Its credit period and days sales outstanding (DSO) are both 30 days. Cash discount Decisions. k. The credit manager estimates that. 15 .000. Answer (A) and (B) if the applicable income tax rate is 40 percent. Page 3 of 9 . Inc. and 1.000 units of a major component part each year. The firm's cost of financing inventory balances is 15%.000.5 percent. what incremental cost of investment is required to support the change in policy? 17 .000.5 percent. Wilbur Co. recommend whether it would be better to give up the cash discount or take the discount and borrow from a bank at 20% annual interest. Its credit period and average collection periods are both 30 days. if the firm extends its credit period to 45 days so that its days sales outstanding increases to 45 days. The Electra Car Company purchases 20. The firm's order costs are P200 per order and the carrying cost per unit is P2 per year.000 but production costs would rise about P40. S Mart has sales of P3 million. is 12. B. However. Assume a tax rate of 40 percent and 360 days per year.000. exclusive of the cost of carrying receivables of 15% and bad debt expenses. It aims to increase inventory turnover form the present 9 times to 12 times next year. Average inventory levels would decline by P300. Trade Credit 18 . while maintaining the same level of sales.5% of its sales end as bad debts. If the new system is able to reduce the firm's inventory level and increase the firm's inventory turnover to 5. how much cash will be freed up? B. It expects short-term interest rates to average 10% for the coming year. At what interest rate would the cost of financing additional inventory under level production be equal to the added production costs of seasonal production?(ignore income taxes) C. Ever Company is considering switching from level production to seasonal production in order to lower very high inventory costs.

Townbank will lend at a 13% interest rate on a discounted loan from three months. should it forego the discount? C. with a 20 percent compensating balance which earns 5% interest income. with a 15 percent compensating balance. 1year loan. What is the effective rate of interest charged by each bank? A.000.75 percent annual rate on a discount loan. A 8. but the P50. D. should the firm forego the discount? 21 . payable at the end of the year. Which alternative has the lowest effective annual interest rate? 60. An 8. net 60. Calculate the effective annual interest rate for each alternative. Redo requirement (A) to (F) assuming the loan is for four (4) months. D. The bank balance earns 5% interest income. Calculate the effective annual interest rate for each alternative. with no compensating balance required and interest due at the end of the year.000 is repayable in monthly installments during the year. A. Island City Bank has offered DM Company the following alternatives. Tyler Company needs P100.000.75 percent annual rate on a discount loan. with a 20 percent compensating balance and an existing cash balance of P150.75 percent annual rate on a discount loan.MANAGEMENT ADVISORY SERVICES Working Capital Management Short-term Loan 19 . What is the cost of foregoing the discount? C. owner of DM Company is negotiating with Island City Bank for a P1M. C. Divina Mendez.000 to take advantage of a discount based on terms of 3/10.000 E. Suppose that Tyler normally banks with Barangay Bank and maintains deposit balance of P15.75 percent annual rate on a discount loan. 22 . If in (B) above the bank requires a 20% compensating balance for the loan. B.25 percent annual rate on a simple interest loan. Dela Merced. A 12. If Lance can borrow from Lending Bank at a 16%. B. A 8. A 8. Which alternative has the lowest effective annual interest rate? A. A 12 percent annual rate on a simple interest loan.000 amount. Lance Hardware can buy equivalent materials from two-distributors. what amount would have to be borrowed and what would the effective interest rate be? C. with a 20 percent compensating balance required and interest again due at the end of the year. with a 20 percent compensating balance required and interest again due at the end of the year.75 percent annual rate on a discount loan.000. A 8. A 9. Island City Bank has offered DM Company the following alternatives. How much would Tyler have to borrow from each bank in order to take the discount? B. with a 20 percent compensating balance.5 percent annual rate on a simple interest loan. which of the two suppliers should it purchase from if supply prices are comparable. A 9 percent annual rate on a simple interest loan. net Exercises & Problems Page 4 of 9 . Interest is figured as 8 percent of the P50. A. Supplier A offers term 1/10. F. B. net 30 whereas Supplier B provides terms of 2/15. Barangay Bank has agreed to lend the money at a 12% rate with a 15% compensating balance requirement. owner of DM Company is negotiating with Island City Bank for a P500. Short-term Financing Alternatives 20 . with a 20 percent compensating balance and an existing cash balance of P150. with no compensating balance required and interest due at the end of the year. If Lance foregoes the discount. D. 1-year loan.

P900. on the average.000 Accounts receivable 66.000. P77. 7. P70.000 65. what amount of working capital must Texas finance? A. P68.000 6.000 B. Sales for last year were P100 million.45.500 8. net 30. P60.MANAGEMENT ADVISORY SERVICES Working Capital Management MULTIPLE CHOICE 1.000 Total P106.8 percent B.800. 67 days D.000 which are to be paid uniformly.000 59. the proposed relaxation of credit to standards will result in an expected increase in the average accounts receivable balance of Page 5 of 9 . Forty percent of the customers pay on the tenth day and take discounts.500 D. P40 for every cash conversion to marketable securities. 45 days 5. a receivables conversion period of 38 days. P1. Hep has the opportunity to invest the money at 24% per annum. 9.000 and no current liabilities. and dividend payout ratio = 0.500 7.000 P121.10.000. May Co.075. The company spends. P2.000 of which 80% are expected to be credit sales at terms of n/30. Silver Company has the following ratios: A*/S = 1. or 45 percent.8 percent D.000 4. If the foregoing cycles are constant. 113 days B.000 10.850. 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Cash P 20. Total sales for the year are P900.000 P 20. Balance Sheet (In million pesos) Assets Current assets P50 Fixed assets Total. Collectrite Company sells on terms 3/10. All assets (including fixed assets) and current liabilities will vary directly with sales. Based on a 360-day year. P2. has a total annual cash requirement of P9.000 P118. P55. P67.000 C.4: profit margin = 0. If sales grow by 10 percent next year.000 C.000 D. What is the average amount of receivables? A.000 B. and a payable payment period of 30 days.000 D. the required new financing (RNF) to finance the expansion is A.000 P 10. P77. P4.500.000 B.000 D. P3..650. and the firm generally pays its suppliers in 20 days. Palma Company's budgeted sales for the coming year are P40. Hep Inc. The table below displays its wide variation in current asset components.000 P 15. Texas usual credit terms to its customers is 30 days. the other 60 percent pay. Color Paint Company has plants in 3 major cities. P72.6 percent 3.200 B.000 If May's policy is to finance all fixed assets and half the permanent current assets with longterm financing and rest with short time-financing. on average.000 88.9 percent C.000 Inventory 20.000. 3.6. 40 P90 Liability and Stockholders Equity Accounts payable and accruals Notes payable .000 B.000 C.000 P100. P45.400. 45 days after their purchases.000 C.000 D. P150. Color Paint is already using assets at full capacity. Texas Company turns out 200 calculators a day at a cost of P250 per calculator for materials and variable conversion cost. Assuming that these ratios will remain constant and that all liabilities increase spontaneously with increases in sales. what is the maximum growth rate Silver Company can achieve without having to employ nonspontaneous external funds? *Spontaneous assets and liabilities A. P5. and the balance sheet at year-end is similar in percentage of sales to that of previous years (and this will continue in the future).400. 4.long term Common stock Retained earnings Total P25 30 15 20 P90 Color Paint has an after-tax profit margin of 5 percent and a dividend payout ratio of 30 Exercises & Problems percent. L*/S = 0. What is the optimal cash conversion size? A.000 47. P100.000 C. What is the length of the firm's cash conversion cycle? A.625 2. 83 days C. P155.000 25. has total fixed assets of P100. The Gold Company has an inventory conversion period of 75 days. Palma 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. what is the level of long-term financing? A. It takes the firm 18 days to convert raw materials into calculator. Sales last year were P100 million. P1.

69 percent Questions 12 & 13 are based on the following information.65% C. 40 percent of Globe's customers take the 2 percent discount. 26.250 C.000 D.000 B. 30.00% B. 19. 17.50% D. but generally does not pay until 40 days after the invoice date.000 B.5 days respectively 11. What is the approximate effective interest rate if the loan is an add-on interest loan with 12 monthly payments? A. 19. respectively B.5 days. how much would you have to borrow to have the use of P100.29 percent B. The current cost of capital for Tempo is 12%. P20. As a condition of the loan.000 Working Capital Management C. A firm buys on terms of 2/10. half of the customers who do not take the discount are expected to pay on time. What is the effective interest rate if the loan is a discount loan with a 10 percent compensating balance? A. 17. P540.50% B.700. P1.620. P100. 22. If Tempo's annual sales are P3.750 D.94 percent D. P2. respectively C. What is approximate cost of the "non-free" trade credit? A. 24. net 30. therefore bad debt losses are not expected to rise above their present 2 percent level. P56.00% D.00% 16. Its purchases total P1. The Tempo's variable cost ratio is 60 percent and annual fixed costs of P600. 16 2% C.and after the. 20.250 10.50% B. 17. 15. 15.56% Questions 15 thru 18 are based on the following information. P133.000 per year.change of credit policy? A.50% 17.000 B. 14.65% C. net 30.000 D. 12. P60. 14 percent C. 8. Globe.000 9. 26. You plan to borrow P100. which offers to lend you the money at a 15 percent nominal.000 in its account for transaction purposes. Regardless of the credit terms. However. What is the effective interest rate if the loan is discount loan? A.5 days and 22. respectively D. If a firm purchases raw materials from its supplier on a 2/10.6 million per year. The checking account earns interest at an annual rate of 3%. 17. 20.000 C.65% C. 17.5 days. 27 days and 22. Under the new term. How much "non-free" trade credit does the firm use on average each year? A.77% C.110 D. what is the firm's carrying cost on accounts receivable.000 at an annual interest rate of 8%. 8. P120.000? A.080. the company is required to maintain a compensating balance of P100. 21.000 13. P90. whereas the remainder will pay 10 days late.44% B. 9. or stated. the equivalent annual effective interest (using 360-day year) of continuously giving up a cash discount and making payment on the 50th day is A. P900. Globe's variable cost ratio is 75 percent.MANAGEMENT ADVISORY SERVICES A.00% D.9% B. P281. 22. net 30. P111.000 in its checking account. 12.000 and all sales are on credit. The Tempo Company has an inventory conversion period of 60 days. 7. Inc. the more generous cash discount terms are expected to increase sales from P2 million to P2.4% D.000 from your bank. Ordinarily. P168. a receivable conversion period of 30 days. A company obtained a short-term bank loan of P500. 21. discount customers are expected to rise to 50 percent. the interest rate on funds invested in accounts receivable is 9 percent. is considering changing its credit terms from 2/15. and a payable payment period of 45 days. What is the effective interest rate of the loan? A.5 days and 27 days. 17.50% 18.000. 13. the company maintains a balance of P50. At present. n/50 term. P120. In order to speed collections. and the firm's income tax rate is 40 percent What are the days sales outstanding (DSO) before.5% 14.333 Exercises & Problems Page 6 of 9 .00% D.5 days and 21. using 360 days year? A. The change does not involve a relaxation of credit standards. rate on a 1-year loan.250 B.000 C. Under the terms of question no. to 3/10.375. P30.

pays in 15 days. net 30. City Sports would have to borrow from a bank at an annual rate of 10% in order to take any cash discounts. net 60. offer terms of 1 ½ / 15.13 percentage points less than the bank loan C. Gees purchases under terms of 2/10.) A. Purchase from Z and pay in 60 days 20. B. X Co. Which means of financing should Gees use? (Use the approximate cost of trade credit. Bank loan. since the cost is about 12. Trade credit. Management estimates that P2. Inc. Bank loan. since the cost is about 1. offers terms of 2/10.400.. Which one of the following would be the most attractive for City Sports? A. since the cost is about 3. Z Inc.13 percent points less than trade credit D.13 percentage points less than trade credit SOLUTIONS Exercises & Problems Page 7 of 9 . but management believes payment could be delayed 30 additional days without penalty. net 40. Presently. and borrows any money needed from the bank C. or the company can finance the expansion by delaying to payment to its suppliers. since the cost is about 3.MANAGEMENT ADVISORY SERVICES Working Capital Management 19. that is. payment could be made in 70 days. Purchase from Y and pay in 30 days D. Purchase from X and pay in 30 days B.24 percent.000 will be required to put this new pump into operation. Purchase from X. Gees Pipeline. Trade credit. Funds can be obtained from a bank at 10 percent discount interest. has developed plans for new pump that will allow more economical operation of the company’s oil pipelines. Y Enterprises offers terms of 1/10. net 30. Three suppliers of baseball equipment offer different credit terms to City Sports.

0001 20020.000.000Inc in RE(630.000. B.333343.450.000 3.500) – 75.000 (1.000 (P750.000) B.300. AR = 55. P480.417 x 0. (a) (b) Inc in SNA1.000 x 4.750)Inc.0002. increase days AP 72. P18. 1.000 + 19. 127.000 B.000) (3.000.000 (1. 8 .000 x 0. Inc bef tax83.000 – 295.750135.800. reduce days inventory(increase inventory turnover).000. D. P90.000 x 6% C.5 M (30 M x 102/360 reduce days AR (increase AR turnover). OldNewChangeP&L EffectSales3.5% 3%Bad debts45.000 x 2) B.75065.200. 2 .000 16 .000 15 . B.250 13 OldNewChangeP&L EffectSales2.000412. C.250.450.800. temporary financing = 21. A.020.000 1.000Bad debts %S1.000 – P45.0009.200 .750 (206.0001.200.720.000 .000.0003.23 14 .000300.6Inc’l Net Income50.000 + 43.000204. 125.000250.000x 15%(9.000 4 . New CCC = 30 days (20 + 40 – 30) WC 37.000 (40.0003.250)(385. 132 days (72 + 60) 102 (132 – 30) 8.20010.000)(450.500VC ratiox 40%Inc.250.500.500.8 million 1. Max.000 A.500 Permanent assets = 59. in AR Inv’t81.400 5.000 C.156.750.000 10 .000(150.5%(6.0002 40010.5) 1 2a 2b 2c Inc in SNA450.500 x 600 D.000 3 . Permanent financing = Cash conversion cycle = 32 days (22 + 40 – 30) B.000Inventory turnover912Inventory5.300.500 x 600 x 32) C.000. P150.000 C.500. P18. in AR Inv’t65.5 days x 12%) – 90.00020.0003. P1. AR = 70.5 million (35 – 30) x 1.750.000) .250.900.000.000 P1.000)DSO3045AR250.000x 0. Inc bef tax161. A.000 (300.000. 9 .250)DSO3045AR208. A.0001.000)(604.000Bad debtsx 2.000. A. P75.593.20x 12.000 DSO = 28 days (10 x 40%) + (40 x 60%) (900.000/360 x 28) DSO = 22 days (10 x 40% +30 x 60%) 12 .000(9. A.750)(311. 4. Order Size# of ordersOrder CostCarrying CostTotal20.000 OldNewDiffSales10 million10 millionInventory turnover25Inventory5.0004 800 5.632.800 x 700 x 30 5 6 7 .800)390.000 5.00010.0001.000. 3.000Inc in RE(453.500162.900.000x 60%180.200.0002.027.000 x 0. P45.8 million (1.000 P90. A.000 x 10%) OldNewDiffCost of Sales45 million45.000 – 425.250 – 112.750)78.000 11 .6Inc. 2.4100.800 1.000.000) (40.50) (43. 28.000 5.1 .

43%Supplier D2/10 net 30201836. 2. Effective interest rate = 12% (12/85) 22 .9. A.25  8011. Principal = 100. Supplier A = 18.12.359 (100. Answer is the same Yes.75 20 .28% 20)11.2(20.88%10. A. B. 20% (16/80). pay supplier within discount period C. A.33% B.145%9.59%Supplier C2/15 net 45301224.25/96.000 (300.12% Townbank = 13.33%17. Trade discount = 22.44% (3.9675) D. cost savings of 5.000 (40/300) 18 . 16%  (100 – 8. daysXNominalEffectiveSupplier A2/10 net 5545816.74%27.5625% 9.25% 1148% 8.33% C.75 – .10. Barangay Bank = 117. 13.23% 8.000 x 15%) – 40.85) Townbank = 103.75) x 4 B.35%D.000)(200 B.5%E.5625%C. 21 .75/(100 – 8.27% C.73%43. B.54%Supplier B3/10 net 5545824. D.10. Yes.000 17 2 .647 (100. A.11. 11.5%B.000. forego the discount.5%12.86%9. One-year4-monthsA.86% 19 .49%27.000  0.18% Supplier B = 16. Barangay Bank = 14. Borrow at 16%.000  0.05%F.75 – 15) 8/50 9/80 12% C.12.