FINANCIAL MANAGEMENT 192004

Working Capital Management

1. Which of the following is not a function of financial management?

a. Financing c. Internal Control
b. Risk-management d. Capital budgeting
2. The inventory conversion period is calculated as follows:
a. Average inventory ÷ Cost of sales per day c. Average inventory ÷ Accounts receivable
b. Year-end inventory ÷ Cost of sales per day d. Year-end inventory ÷ Cost of sales
3. The payables deferral period is calculated as follows
a. Average payables ÷ Sales per day c. Average payables ÷ Purchases per day
b. Beginning payables ÷ Sales per day d. Average payables ÷ Cost of goods sold
4. All of the following statements in regard to working capital are correct, except:
a. Current liabilities are an important source of financing for many small firms.
b. Profitability varies inversely with liquidity.
c. The hedging approach to financing involves matching maturities of debt with specific financing needs.
d. Financing permanent inventory buildup with long-term debt is an example of an aggressive working
capital policy.
5. Determining the appropriate level of working capital for a firm requires
a. Evaluating the risks associated with various levels of fixed assets and the types of debt used to
finance these assets.
b. Changing the capital structure and dividend policy of the firm.
c. Maintaining short-term debt at the lowest possible level because it is generally more expensive than
long-term debt.
d. Offsetting the benefit of current assets and current liabilities against the probability of technical
insolvency.
6. Which of the following actions is likely to reduce the length of a firm’s cash conversion cycle?
a. Adopting a new inventory system that reduces the inventory conversion cycle period.
b. Adopting a new inventory system that increases the inventory conversion period.
c. Increasing the average days sales outstanding on its accounts receivable.
d. Reducing the amount of time the firm takes to pay its suppliers.
7. Eagle Sporting Goods has P2.5 million in inventory and P2million in accounts receivable. Its average daily
sales are P100,000. The firm’s payables deferral period is 30 days and average daily costs of sales are
P50,000. What is the length of the firm’s cash conversion period?
a. 100 days b. 60 days c. 50 days d. 40 days
8. Jones Company has P5,000,000 of average inventory and cost of sales of P30,000,000. Using a 365-day
year, calculate the firm’s inventory conversion period.
a. 30.25 days b. 60.83 days c. 45.00 days d. 72.44 days
9. The length of time between the acquisition of inventory and payment for it is called the
a. Operating cycle c. Accounts receivable period
b. Inventory conversion period d. Accounts payables deferral period
10. If everything else remain constant and a firm increase its cash conversion cycle, its profitability will likely
a. Increase c. Decrease
b. Increase if earnings are positive d. Not be affected
11. An organization offers its customers’ credit terms of 5/10 net 20. One-third of the customers take the cash
discount and the remaining customers pay on day 20. On average, 20 units are sold per day, priced at
P10,000 each. The rate of sales is uniform throughout the year. Using a 360-day year, the organization has
day’s sales outstanding in accounts receivable, to the nearest full day of
a. 13 days b. 15 days c. 17 days d. 20 days
12. Troy Toys is a retailer operating in several cities. The individual store managers deposit daily collections at a
local bank in a noninterest-bearing checking account. Twice per week, the local bank issues depository
transfer check (DTC) to the central bank at headquarters. The controller of the company is considering using
a wire transfer instead. The additional cost of each transfer would be P25; collections would be accelerated by
two days; and the annual interest rate paid by the central bank is 7.2% (0.02% per day). At what amount of
pesos transferred would it be economically feasible to use a wire transfer instead of DTC? Assume a 360-day
year.
a. It would never be economically feasible c. Any amount greater than P173
b. P125,000 or above d. Any amount greater than P62,500
13. Which of the following is true about electronic funds transfer from a cash flow standpoint?
a. It is always beneficial from a cash flow standpoint
b. It is never beneficial from a cash flow standpoint
c. It is beneficial from a cash receipts standpoint but not from a cash disbursements standpoint.
d. It is beneficial from a cash disbursements standpoint but not from a cash receipts standpoint.
14. Management of Radker Corp. is considering a lockbox system. The bank will charge P10,000 annually for the
service, which will save the firm approximately P5,000 in processing costs. The lockbox system will reduce
the float for cash receipts by three days. Assuming that the average daily receipts are equal to P100,000 and
short-term costs are 5%, calculate the benefit or loss from adopting the lockbox system.
a. P5,000 loss c. P10,000 benefit
b. P10,000 loss d. P5,000 benefit
15. Which of the following is true about a firm’s float?
a. A firm strives to minimize the float for both cash receipts and cash disbursements.
b. A firm strives to maximize the float for both cash receipts and cash disbursements.
c. A firm strives to maximize the float for cash receipts and minimize the float for cash disbursements.
d. A firm strives to minimize the float for cash disbursements and maximize the float for cash receipts.
16. A firm is evaluating whether to establish a concentration banking system. The bank will charge P5,000 per
year for maintenance and transfer fees. The firm estimates that the float will be reduced by two days if the
concentration banking is put into place. Assuming that average daily receipts are P115,000 and short-term
interest rates are 4%, what decision should the firm make regarding the concentration banking system?
a. Do not establish the concentration banking system because the net cost is P5,000.
b. Do not establish the concentration banking system because the net cost is P21,000
c. Establish the concentration banking system because the net benefit is P115,000.
d. Establish the concentration banking system because net benefit is P4,200
17. A firm is evaluating whether to establish a lockbox system. The bank will charge P30,000 per year for the
lockbox and the firm will save approximately P8,000 on internal processing costs. The firm estimates that the
float will be reduced by three days if the lockbox system is put into place. Assuming that average daily cash
receipts are P350,000 and short-term interest rates are 4%, what decision should the firm make regarding the
lockbox system?
a. Do not establish the lockbox system because the net cost is P30,000
b. Do not establish the lockbox system because the net cost is P22,000
c. Establish the lockbox system because the net benefit is P12,000
d. Establish the lockbox system because the net benefit is P20,000
18. An organization has an opportunity to establish a zero balance account system using four different regional
banks. The total amount of the maintenance and transfer fees is estimated to be P6,000 per annum. The
organization believes that it will increase the float on its operating disbursements by an average of four days
and its cost of short-term funds is 4.5%. assuming the organization estimates it average daily operating
disbursements to be P40,000 what decision should the organization make regarding this opportunity?
a. Do not establish the zero balance account system because it results in estimated additional net costs
of P6,000.
b. Do not establish the zero balance account system because it results in estimated additional net costs
of P1,200.
c. Establish the zero balance account system because it results in estimated net savings of P1,200.
d. Establish the zero balance account system because it results in estimated net savings of P7,200.
19. A working capital technique that increases the payable float and therefore delays the outflow of cash is
a. Concentration banking c. Electronic Data Interchange
b. A draft d. A lockbox system
20. Newman Products has received proposals from several banks to establish a lockbox system to speed up
receipts. Newman receives an average of 700 checks per day averaging P1,800 each, and its cost of short-
term funds is 7% per year. Assuming that all proposals will produce equivalent processing results and using a
360-day year, which one of the following proposals is optimal for Newman?
a. A P0.50 fee per check c. A fee of 0.03% of the amount collected.
b. A flat fee of P125,000 per year d. A compensating balance of P1,750,000
21. A firm has daily cash receipts of P100,000. A bank has offered to reduce the collection time on the firm’s
deposits by two days for a monthly fee of P500. If money market rates are expected to average 6% during the
year, the net annual benefit (loss) from having this service is
a. P3,000 c. P0
b. P12,000 d. P6,000
22. A minimum checking account balance that a firm must maintain with a commercial bank is a
a. Transaction balance c. Precautionary balance
b. Compensating balance d. Speculative balance
23. A firm has daily receipts of P100,000. A bank had offered to reduce the collection on the firm’s deposits by
two days for a monthly fee of P500. If money market rates are expected to average 6% during the year, the
net annual benefit from having this service is
a. P0 b. P3,000 c. P6,000 d. P12,000
24. Cleveland Masks and Costumes Inc (CMC) has a majority of its customers located in the states of California
and Nevada. Keystone National Bank, a major west coast bank, has agreed to provide a lockbox system to
CMC at a fixed fee of P50,000 per year and a variable fee of P0.50 for each payment processed by the bank.
On average, CMC receives 50 payments per day, each averaging P20,000. With the lockbox system, the
company’s collection float will decrease by 2 days. The annual interest rate on money market securities is 6%.
If CMC makes use of the lockbox system, what would be the net benefit to the company? Use 365 days per
year.
a. P51,750 b. P60,875 c. P111,750 d. P120,875
25. Which changes in costs are most conducive to switching from a traditional inventory ordering system to a just-
in-time ordering system?
Cost per purchase order Inventory unit carrying costs
a. Increasing Increasing
b. Decreasing Increasing
c. Decreasing Decreasing
d. Increasing Decreasing
26. To determine the inventory reorder point, calculations normally include the
a. Ordering Cost c. Average daily usage
b. Carrying Cost d. Economic order quantity
27. The economic order quantity formula assumes that
a. Periodic demand for the good is known
b. Carrying costs per unit vary with quantity ordered.
c. Costs of placing the order vary with quantity ordered
d. Purchase costs per unit differ due to quantity discounts.
28. Ral Co. sells 20,000 radios evenly throughout the year. The costs of carrying one unit in inventory for one
year is P8 and the purchase order cost per order is P32. What is the economic order quantity?
a. 625 b. 400 c. 283 d. 200
29. The following information pertains to material X that is used by Sage Co.
Annual usage in units 20,000
Working days per year 250
Safety stock in units 800
Normal lead time in working days 30
Units of material X will be required evenly throughout the year. The reorder point is
a. 800 b. 1,600 c. 2,400 d. 3,200
30. Firms that maintain very low or on inventory levels
a. Have higher ordering costs c. Have higher ordering and carrying costs
b. Have higher carrying costs d. Have lower ordering and carrying costs.
31. An example of a carrying costs is
a. Disruption of production schedules c. Handling costs
b. Quantity discounts lost d. Obsolence
32. Ethan Inc has seasonal demand for its products and management is considering whether level production or
seasonal production should be implemented. The firms’ short-term interest cost is 8% and management has
developed the following information to make the decision:
Alternative 1 – Level Production Alternative 2 – Seasonal Production
Average Inventory P2,000,000 P1,500,000
Production Costs P6,000,000 P6,050,000
Which alternative should be accepted and how much is saved over the other alternative?
a. Alternative 1 with P500,000 in savings c. Alternative 2 with P10,000 in savings
b. Alternative 2 with P50,000 in savings d. Alternative 1 with P10,000 in savings
33. Using the information in the previous number, at what rate of short-term interest rate would the two
alternatives have the same cost?
a. 6% b. 9% c. 10% d. 12%
34. The amount of inventory that a company would tend to hold in stock would increase as the
a. Sales level falls to a permanently lower level c. Variability of sales decreases
b. Cost of carrying inventory decreases d. Cost of running out stock decreases
35. An appropriate technique for planning and controlling manufacturing inventories, such as raw materials,
components and subassemblies, whose demand depends on the level of production is
a. Materials requirements planning c. Capital budgeting
b. Regression analysis d. Linear programming
36. The procedures followed by the firm for ensuring payment of its accounts receivables are called its
a. Discount policy c. Collection policy
b. Credit policy d. Payables policy
37. Effective September 1, a company initiates seasonal dating as a component of its credit policy, allowing whole
sale customers to make purchases early but not requiring payment until the retail selling season begins. Sales
occur as follows:
Date of sale Quantity sold
September 1 300 units
October 1 100 units
November 1 100 units
December 1 150 units
January 1 50 units
 Each unit has a selling price of P10 regardless of the date of sale.
 The terms of sale are 2/10 net 30, January 1 dating.
 All sales are on credit.
 All customers take the discount and abide by the terms of the discount policy.
 All customers take advantage of the new seasonal dating policy.
 The peak selling season for all customers is mid-November to late December
For the selling firm, which of the following is not an expected advantage to initiating seasonal dating?
a. Reduced storage costs c. Attractive credit terms for customers
b. Reduced credit costs d. Reduced uncertainty about sales volume
38. For sales after the initiation of the seasonal dating policy on September 1, total collections on or before
January 1 will be
a. P0 b. P6,370 c. P6,860 d. P7,000
39. Using the same information in the previous number, which of the following describes the appropriate formula
for days sales outstanding?
a. Average receivables ÷ Sales per day c. Sales ÷ Average receivables
b. Receivables balance ÷ Sales per day d. Receivables balance ÷ Total sales
40. A company plans to tighten its credit policy. 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 projected sales would be 5% less if the proposed new credit policy were
implemented. The firm’s short-term interest cost is 10%.

Projected sales for the coming year are P50million. Calculate the peso impact on accounts receivable of this
proposed change in credit policy. Assume a 360-day year.
a. P3,819,445 decrease c. P3,333,334 decrease
b. P6,500,000 decrease d. P18,749,778 decrease
41. Using the same information in the previous number, what effect would the implementation of this new credit
policy have on income before taxes?
a. P2,500,000 decrease c. P83,334 increase
b. P2,166,667 decrease d. P33,334 increase
42. The sales manager at Ryan Company feels confident that if the credit policy at Ryan’s were changed, sales
would increase and consequently, the company would utilize excess capacity. The two proposals being
considered are as follows:
Proposal A Proposal B
Increase in sales P500,000 P600,000
Contribution margin 20% 20%
Bad debt percentage 5% 5%
Increase in operating profits P75,000 P90,000
Desired return on sales 15% 15%
 Currently, payment terms are net 30. The proposed payment terms for Proposal A and Proposal B are net 45
and net 90, respectively. An analysis to compare these two proposals for the change in credit policy would
include all of the following factors except the
a. Cost of funds for Ryan
b. Current bad debt experience
c. Impact on the current customer base of extending terms to only certain customers
d. Bank loan covenants on days sales outstanding
43. A company enters into an agreement with a firm who will factor the company’s accounts receivable. The
factor agrees to buy the company’s receivables which average P100,000 per month and have an average
collection period of 30 days. The factor will advance up to 80% of the face value of receivables at annual rate
of 10% and charge a fee of 2% on all receivables purchased. The controller of the company estimates that the
company would save P18,000 in collection expenses over the year. Fees and interest are not deducted in
advance. Assuming a 360-day year, what is the annual cost of financing?
a. 10.0% b. 14.0% c. 16.0% d. 17.5%
44. A company with P4.8million in credit sales per year plans to relax is credit standards, projecting that this will
increase credit sales by P720,000. The company’s average collection period for new customers is not
expected to change. Variables costs are 80% of sales. The firm’s opportunity cost is 20% before taxes.
Assuming a 360-day year, what is the company’s benefit (loss) from the planned change in credit terms?
a. P0 b. P28,800 c. P144,000 d. P120,000
45. Gild Company has been offered credit terms of 3/10, net 30. Using a 365-day year, what is the nominal cost of
not taking advantage of the discount if the firm pays on the 35th day after the purchase?
a. 14.2% b. 32.2% c. 37.6% d. 45.2%
46. Newton Corporation is offered trade credit terms of 3/15, net 45. The firm does not take advantage of the
discount, and it pays the account after 67 days. Using a 365-day year, what is the nominal annual cost of not
taking the discount?
a. 18.2% b. 21.71% c. 23.48% d. 26.45%
47. If a firm is offered credit terms 2/10, net 30 on its purchases. Sound cash management practices would mean
that the firm would pay the account on which of the following days?
a. Day 2 and 30 b. Day 2 and 10 c. Day 10 d. Day 30
48. The following forms of short-term borrowing are available to a firm:
 Floating lien
 Factoring
 Revolving credit
 Chattel mortgages
 Banker’s acceptances
 Line of credit
 Commercial paper

The forms of short-term borrowing that are unsecured credit are

a. Floating lien, revolving credit, chattel mortgage and commercial paper

b. Factoring, chattel mortgage, banker’s acceptance and line of credit
c. Floating lien, chattel mortgage, banker’s acceptances, and line of credit
d. Revolving credit, banker’s acceptances, line of credit and commercial paper.
49. A company obtaining short-term financing with trade credit will pay a higher percentage financing cost,
everything else being equal, when
a. The discount percentage is lower c. The items purchased have lower
price
b. The items purchased have higher price d. The supplier offers a longer discount
period
50. If a firm borrows P500,000 at 10% and is required to maintain P50,000 as a minimum compensating balance
at the bank, what is the effective interest rate on the loan?
a. 10.0% b. 11.1% c. 9.1% d. 12.2%
51. If a retailer’s terms of trade are 3/10, net 45 with a particular supplier, what is the cost on an annual basis of
not taking the discount? Assume a 360-day year.
a. 24.00% b. 37.11% c. 36.00% d. 31.81%
52. Hagar Company’s bank requires a compensating balance of 20% on a P100,000 loan. If the stated interest on
the loan is 7%, what is the effective cost of the loan?
 a. 5.83% b. 7.00% c. 8.40% d. 8.75%
53. Cyber Age Outlet, a relatively new store, is a café that offers customers the opportunity to browse the internet
or play computer games at their tables while they drink coffee. The customer pays a fee based on the amount
of time spent signed on to the computer. The store also sells books, tee shirts, and computer accessories.
Cyber Age has been paying all of its bills on the last day of the payment period, thus forfeiting all supplier
discounts. Shown below are data on Cyber Age’s two major vendors, including average monthly purchases
and credit terms.
Vendor Average monthly purchases Credit terms
Web Master P25,000 2/10, net 30
Softidee 50,000 5/10, net 90
Assuming a 360-day year and that Cyber Age continues paying on the last day of the credit period, the
company’s weighted-average annual interest rate for trade credit (ignoring the effects of compounding) for
these two vendors is
a. 27.0% b. 25.2% c. 28.0% d. 30.2%
54. Using the same information in the previous number, should Cyber Age use trade credit and continue paying at
the end of the credit period?
a. Yes, if the cost of alternative short-term financing is less.
b. Yes, if the firm’s weighted-average cost of capital is equal to its weighted-average cost of trade credit.
c. No, if the cost of alternative long-term financing is greater.
d. Yes, if the cost of alternative short-term financing is greater.
55. 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 compensating balance of P50,000 in its checking account.
The company’s checking account earns interest at an annual rate of 2%. Ordinarily, the company maintains a
balance of P25,000 in its checking account for transaction purposes. What is the effective interest rate of the
loan?
a. 6.44% b. 7.11% c. 5.80% d. 6.66%
56. A manufacturing firm wants to obtain a short-term loan and has approached several lending institutions. All of
the potential lenders are offering the same nominal interest rate, but the terms of the loans vary. Which of the
following combinations of loan terms will be most attractive for the borrowing firm?
a. Simple interest, no compensating balance c. c. Simple interest, 20% compensating
balance required
b. Discount interest, no compensating balance d. Discount interest, 20% compensating balance
required
57. Elan Corporation is considering borrowing P100,000 from a bank for one year at a stated interest rate of 9%.
What is the effective interest rate to Elan if this borrowing is in the form of a discount note?
a. 8.10% b. 9.00% c. 9.81% d. 9.89%
58. The Red 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 1/2% commitment fee on the unused portion of the line of credit. The average loan balance
during the year was P100,000. The annual cost of this financing arrangement is
a. P6,000 b. P6,500 c. P7,000 d. P7,500
59. Which of the following financial instruments generally provides the largest source of short-term credit for small
firms?
a. Installment loans c. Trade credit
b. Commercial paper d. Mortgage bonds
60. A compensating balance
a. Compensates a financial institution for services rendered by providing it with deposits of funds.
b. Is used to compensate for possible losses on a marketable securities portfolio.
c. Is a level of inventory held to compensate for variations is usage rate and lead time
d. Is an amount paid by financial institutions to compensate large depositors
61. On January 1, Scott Corporation received a P300,000 line of credit at an interest rate of 12% from Main Street
Bank and drew down the entire amount of February 1. The line of credit agreement requires that an amount
equal to 15% of the loan be deposited into a compensating balance account. What is the effective annual cost
of credit for this loan arrangement?
a. 11.00% b. 12.00% c. 12.94% d. 14.12%

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