Monina D.

Cahilig BSA 2-A

CHAPTER 9
R E V I E W Q U E S T I O N S A N D P R O B L E M S

Questions:

1. What are some of the characteristics of a firm with a long operating cycle?
Answer: The firm with a long operating cycle have relatively long inventory periods and
long receivable periods. As a result, the firm keeps the inventory on hand, and allow
the customer to purchase on credit and give them a long time to pay.

2. What are some of the characteristics of a firm with a long cash cycle?
Answer: The firms with a long cash cycle have a long time between the time the firm
purchased inventory is paid for and the time that inventory is sold and payment is
received. As a result, firms have relatively short payable periods or relatively long
receivable cycles

3. Miracle Manufacturing has recently installed just-in-time (JIT) inventory system.

Describe the effect this is likely to have on the company’s carrying costs, shortage
costs and operating cycle.
Answer: Having JIT recently installed in Miracle Manufacturing inventory system, the
carrying cost will decrease because they will not hold the goods in inventory since JIT
inventory system only makes the goods only as needed or demanded. The shortage
cost will probably increase, depending on how close the suppliers and the needed
materials. Since the goods is only made if it is demanded or needed, it can cause the
operating cycle to decrease since the good is because the inventory period is increased.

4. Is it possible for a firm’s cash cycle to be longer than its operating cycle? Explain
why or why not.
Answer: Cash cycle is equal to operating cycle minus the accounts payable period, it is
not possible for the cash cycle to be longer than operating cycle since the firms are
paying its bills before they are incurred.
Problems:
Problem 1 (Cash Equation)

Corona Corporation has a book net worth of Php 10,380. Long term debt is Php 7,500.
Net working capital, other than cash is Php 2,105. Fixed assets are Php 15,190. How
much cash does the company have? If current liabilities are Php 1,450, what are
current assets?
Answer:
Total Assets = Total Liabilities
Current Assets + Fixed Assets = Long Term Debt + Equity + Current Liabilities
N + 15,190 = 7,500 + 10,380 + 1,450
N + 15,190 = 19,330
N = 19,330 - 15,190
N = 4,140

Cash = Net working capital + Current Liabilities - Current Assets

= 2,105 + 1,450 - 4,140
= Php 585

Problem 2 (Changes in the Operating Cycle)

Indicate the effect that the following will have on the operating cycle. Use letter (I) to
indicate an increase, the letter (D) for a decrease and letter (N) for no change:
Effect
a. Average receivables goes up. ________I_________
b. Credit repayment times for customers are increased. ________I_________
c. Inventory turnover goes from 3 times to 6 times. ________D________
d. Payables turnover goes from 6 times to 11 times. ________I_________
e. Receivables turnover goes from 7 times to 9 times. ________I_________
f. Payment to suppliers are accelerated. ________D________
Problem 3 (Changes in Cycles)

Indicate the impact of the following on the cash and operating cycles, respectively. Use
letter (I) to indicate an increase, the letter (D) for a decrease and letter (N) for no
change:
Impact
a. The terms of cash discounts offered
to customers are made less favorable. ________D_________
b. Fewer raw materials than usual are purchased. ________I_________
c. An increased number of customers
begin to pay in cash instead of with credit. ________I_________
d. The cash discounts offered by suppliers
are decreased; thus, payments are made earlier. ________I_________
e. A greater percentage of raw material
purchases are paid for with credit. ________D__________
f. More finished goods are produced
for inventory instead of for order. ________D_________

Problem 4 (The Operating and Cash Cycle)

Consider the following financial statement information for Avocado Company.

Item Beginning Ending

Inventory Php 1,273 Php 1,401

Accounts receivable 3,872 3,368
Accounts payable 1,795 2,025
Net sales Php 14,750
Cost of goods sold 11,375

Calculate the operating and cash cycles.

Solution:
Operating Cycle = Inventory x 365 + Accounts Receivable x 365
Cost of Sales Credit Sales
= Php128 x 365 + Php 504 x 365
Php11, 375 Php14, 750
= 4.11 days + 12.47 days
= 16.58 days

Cash Conversion Cycle = Operating Cycle - Accounts Payable x 365

Cost of Sales
= 16.58 days - Php2, 025 – 1, 795 x 365
Php11, 375
= 16.58 days - 7.38 days
= 9.20 days

Problem 5 (Working Capital)

The questions (a) through (g) refer to Lockdown Manufacturing Company. Use the
following information to solve for (a) and (b).

Lockdown Manufacturing Company

Statement of Financial Position
As of December 31, 2018

Cash Php 20,000 Current liabilities (10%) Php 200,000

Marketable securities 30,000 Long-term liabilities (15%) 300,000
Accounts receivable 150,000 Total liabilities Php 500,000
Inventory 200,000
Total current assets Php 400,000 Stockholders’ equity Php 500,000
Net fixed assets 600,000 Total Liabilities and
Total assets Php 1,000,000 Owners’ equity Php 1,000,000
During 2018, the firm’s earnings before interest and taxes were 20 percent of Php
800,000 in sales. The income tax rate is 34 percent.

Required:
a. Determine the level of working capital, net working capital and current ratio.
Answer:
Net Working Capital = Current Assets – Current Liabilities
= Php 400,000 – Php 200,000
= Php 200,000

Current Ratio = Total Current Assets

Total Current Liabilities
= Php 400,000
Php 200,000
= 2 times

b. Calculate the return on equity (net income/stockholders’ equity)

Answer:
Rate of Return on Equity = Net Income
Stockholder’s Equity
= 54,400
500,000

= 0.11%

Use the following information about Lockdown Manufacturing Company to solve for (c)
and (d).
Lockdown Manufacturing Company decides to examine its working capital policy. In
addition to its current strategy of maintaining current assets at 50 percent of sales,
Lockdown is considering two other strategies based on current assets at 30 or 70
percent of next year’s sales. Projected net sales and fixed assets for next year are Php
1,000,000 and Php 600,000, respectively. Lockdown plans to maintain its existing
capital structure of 50 percent debt and 50 percent equity. Current liabilities are to be
40 percent of projected total liabilities.
Required:
c. Calculate Lockdown’s net working capital and current ratio under each of the three
categories.
Answer:
Net Working Capital (50%) = Current Assets – Current Liabilities
= Php 500,000 – Php 200,000
= Php 300,000

Current Ratio = Total Current Assets

Total Current Liabilities
= Php 500,000
Php 200,000
= 2.5 times

Net Working Capital (30%) = Current Assets – Current Liabilities

= Php 300,000 – Php 200,000
= Php 100,000

Current Ratio = Total Current Assets

Total Current Liabilities
= Php 300,000
Php 200,000
= 1.50 times

Net Working Capital (70%) = Current Assets – Current Liabilities

= Php 420,000 – Php 120,000
= Php 300,000

Current Ratio = Total Current Assets

Total Current Liabilities
 = Php 420,000
Php 120,000
= 3.50 times

d. Explain what effect these strategies would have on Lockdown’s liquidity.

The effect it will have on Lockdown Manufacturing Company is that high
liquidity rate. There will be a challenge for the company on how to handle their rates,
since they are changing the rates based on the percentage of sales. From lower rate to
a maximum will be difficult to predict if they do not make their sales constant. But, as
a result the percentage will help them realize what will be the exact rate to be
competitive and either to maintain or increase liquidity rate as well as the net working
capital.

Refer to (b) and the following information about Lockdown Manufacturing Company to
solve for (e) and (f).

Lockdown expects its earnings before interest and taxes in 2019 to be 18 percent of
Php 1,000,000 in sales. Interest rates are projected to remain at 10 percent for short-
term debt and 15 percent for long-term debt. The firm’s tax rate will be 34 percent.

Required:
e. What is Lockdown’s rate of return on equity for each of the three strategies?
Answer:
30% 50% 70%
Net Sales Php 1,000,000 Php 1,000,000 Php 1,000,000
EBIT 180,000 180,000 180,000
Short term Debt (10%) (18,000) (20,000) (26,000)
Long term Debt (15%) (40,500) (49,500) (58,500)
EBT 121,500 110,500 95,500
Income Tax (34%) 41,310 37,570 32,470
Net Income Php 80,190 Php 72,930 Php 63,030
Rate of Return on Equity = 80,190 72,930 63,030
450,000 550,000 650,000
= 17.82% 13.26% 9.7%

f. Describe the relationship between Lockdown’s liquidity and profitability.

Answer: Lockdown Manufacturing Company has increased its liquidity but decreased
its profitability. It is not bad for the firm to gain even a small percentage of profit, it
means that at a certain point the plans and effort was paid off, and the business is
doing good. But, in this case, the profitability of the company is decreasing. The
production maybe overrides the liquidity rather than profitability.

Use the following information about Lockdown manufacturing Company to solve for
(g).

Lockdown wants to determine the impact of changing the financing mix when using an
aggressive current asset strategy of having current assets at 30 percent of sales.
Earnings before interest and taxes are expected to be Php 180,000. Short-term
interest rates are 10 percent and long-term rates are 15 percent. The firm’s tax rate is
34 percent. Lockdown wants to maintain a mix of 50 percent debt and 50 percent
equity under restricted, compromise and flexible financing strategies as shown below.

Lockdown Manufacturing Company Pro Forma Statement of Financial Position As of

December 31, 2019
Financing Mix Strategies
Restricted Compromise Flexible
Current assets Php 300,000 Php 300,000 Php 300,000
Fixed assets 600,000 600,000 600,000
Php 900,000 Php 900,000 Php 900,000

Current liabilities (10%) Php 100,000 Php 300,000 Php 450,000

Long-term liabilities (15%) 350,000 150,000 0
Total liabilities Php 450,000 Php 450,000 Php 450,000
Stockholders’ equity 450,000 450,000 450,000
Total liabilities and
Owners’ equity Php 900,000 Php 900,000 Php 900,000
Required: g. Show the expected return on equity, net working capital and current ratio
for each proposed strategy.
Answer:
Rate of Return on Equity (Restricted) = Net Income
Stockholder’s Equity
= 180,000
450,000

= 0.4%

Rate of Return on Equity (Compromise) = Net Income

Stockholder’s Equity
= 180,000
450,000

= 0.4%

Rate of Return on Equity (Flexible) = Net Income

Stockholder’s Equity
= 180,000
450,000

= 0.4%

Net Working Capital (Restricted) = Current Assets – Current Liabilities

= Php 300,000 – Php 100,000
= Php 200,000

Net Working Capital (Compromise) = Current Assets – Current Liabilities

= Php 300,000 – Php 300,000
= Php 0
Net Working Capital (Flexible) = Current Assets – Current Liabilities
= Php 300,000 – Php 450,000
= Php -150,000

Current Ratio (Restricted) = Total Current Assets

Total Current Liabilities
= Php 300,00
Php 100,00

= 3 times

Current Ratio (Compromise) = Total Current Assets

Total Current Liabilities
= Php 300,00
Php 300,00

= 1 time

Current Ratio (Flexible) = Total Current Assets

Total Current Liabilities
= Php 300,00
Php 450,00

= 0.67 times
 CHAPTER 10
REVIEW QUESTIONS AND PROBLEMS

Questions:

1. In the management of cash and marketable securities, why should the primary
concern be for safety and liquidity rather than maximization of profit?
Answer: Cash and marketable securities are an important part of working capital
management. Cash and Marketable securities are generally used to meet the
transaction needs of the firm and for contingency purposes. Liquidity and safety is
important so that these can be used to make payments at a very short notice, because
the funds must be available when needed. Thus, the primary concern should be with
safety and liquidity rather than the maximum profit.

2. Why does float exist and what effect would electronic funds transfer systems have
on float?
Answer: Float is defined as the difference between the balance shown in a firm’s books
and the balance on the banks record. It arises from the delays Float exists because of
the delay of time in mailing, processing and clearing checks through the banking
system. Electronic funds transfer system, or the electronic movement of funds
between computer terminals, will have the effect of eliminating the need for checks
and thus eliminate float.

3. Why would a financial manager want to slow down disbursements?

Answer: Financial Manager slowing down the disbursements or the processing of
checks against the corporate account for the reason of having the most accurate cash
budgeting and for the firm will be able to increase float and also to provide a source of
short-term financing.

4. “Efficient cash management will aim at maximizing the availability of cash inflows
by decentralizing collections and decelerating cash outflows by centralizing
disbursements”. Discuss.
Answer: Cash is the most important current asset for a business operation. It is the
thing that carry out the business operations, this can be of two forms, generally cash
means currency and other things like cheques, drafts, etc.  and the second type is the
assets that can be converted into cash.  Cash in its own form is an idle asset, unless
employed in some form or another, it does not earn any revenue. To conclude, as the
statement provide, excessive cash will not contribute to the firm’s profits and storage
or keeping the cash will disrupt its manufacturing operations.

5. Would it be possible for a decision to deny credit to your customers to be value

maximizing? How?
Answer: Yes, it is possible for a decision to deny credit to the customers to be value
maximizing. It can be possible with innocent reason such as the customer does not
have credit history or the customer does not satisfy the requirements for the credit.

Problems:
Problem 1 (Determining Float)

Lemon Company shows the following values on its corporate books.

Corporate Books
Initial Amount Php 10,000
Add: Deposits 80,000
Less: Checks 50,000
Balance Php 40,000

The initial amount on the bank’s books is also Php 10,000. However, only Php 70,000
in deposits have been recorded and only Php 25,000 in checks have cleared.

Required:
a. Fill in the table below and indicate the amount of float

Bank’s Books
Initial Amount Php 10,000
Add: Deposits 70,000
Less: Checks 25,000
Balance 55,000
Float (+)15,000
Problem 2 (Determining Float)

Roni’s checkbook shows a balance of Php 6,000. A recent statement from the bank
(receives last week) shows that all checks written as of the date of the statement have
been paid except numbers 423 and 424, which were for Php 620 and Php 400,
respectively. Since the statements date, checks 425, 426 and 427 have been written
for Php 320, Php 700 and Php 440, respectively. There is a 75% probability that
checks 423 and 424 have been paid by this time. There is a 40% percent probability
that checks 425, 426 and 427 have been paid.

Required:
a. What is the total value of the five checks outstanding?
Answer: Php 2,480

b. What is the expected value of payments for the five checks outstanding?
Answer: Check 423 and 424 = 1,020 x 75% = Php 765
Check 425, 426, and 427 = 1,460 x 40% = Php 584
Total expected value = 765 + 584 = Php 1,349

c. What is the difference between parts (a) and (b)? This represents a type of float.
Answer: Difference = Php 2,480 - Php 1,349
= Php 1,131
 CHAPTER 11
R E V I E W Q U E S T I O N S A N D P R O B L E M S

Questions:

1. What are the five Cs of credit? Explain why each is important?

Answer:
a. Character – refers to the probability that the customers will pay their debts or
obligations. Credit reports provide background information on people and firm’s past
performances from a firm’s bankers, their other suppliers, their customers and even
their competitors.
b. Capacity – the judgement of customers’ abilities to pay. It is determined in part by
the customers’ past records and business methods. It may be supplemented by
physical observations of their plants or stores. Again, credit analysts will obtain
judgmental information on this factor from a variety of sources.
c. Capital – measured by the general financial condition of a firm as indicated by an
analysis of its financial system. Special emphasis is given to the risk ratio – the
debt/asset ratio, the current ratio, and the times interest-earned ratio.
d. Collateral – represented by assets that customers may offer as security in order to
obtain credit.
e. Conditions – refer to both general economic trends and to special developments in
certain geographic regions or sectors of the economy that might affect customers’
abilities to meet their obligations.

2. What are some of the factors that determine the length of the credit period? Why the
length of the buyer’s operating cycle often considered an upper bound on the length of
the credit period?
Answer: Some factors that determine the length of the credit period are the 1)
Perishability and collateral value, 2) Consumer demand, 3) Cost, profitability, and
standardization, 4) Credit risk, 5) The size of the account, 6) Competition, and 7)
Customer type. The length of the buyer’s operating cycle often considered as an upper
bound because, if the credit period exceeds a customer ‘s operating cycle, then the
firm is financing the receivables and other aspects of the customer ‘s business that go
beyond the purchase of the selling firm ‘s merchandise.
3. In each of the following pairing, indicate which firm would probably have a longer
credit period and explain your reasoning. a. Firm A sells a miracle cure for baldness;
Firm B sells toupees. b. Firm A specializes in products for landlords; Firm B
specializes in products for renters. c. Firm A sells to customers with an inventory
turnover of 10 times; Firm B sells to customers with an inventory turnover of 20
times. d. Firm A sells fresh fruits; Firm B sells canned fruit. e. Firm A sells and install
carpeting; Firm B sells rugs.
Answer:
a. Firm A sells a miracle cure for baldness; Firm B sells toupees.
The firm that would probably have a longer credit period is B because A is likely
to sell for cash only, unless the product really works. If it does, then they might grant
longer credit periods to entice buyers.
b. Firm A specializes in products for landlords; Firm B specializes in products for
renters.
The firm that would probably have a longer credit period is A because Landlords
have significantly greater collateral, and that collateral is not that simple to be dispose
automatically.
c. Firm A sells to customers with an inventory turnover of 10 times; Firm B sells to
customers with an inventory turnover of 20 times.
The firm that would probably have a longer credit period is A. A‘s customers
turn over inventory is less than B customer’s turn over means they have much longer
inventory period, and thus, will most likely have a longer credit period.
d. Firm A sells fresh fruit; Firm B sells canned fruit.
The firm that would probably have a longer credit period is B. A‘s merchandise
is perishable and B‘s is not, B will probably have a longer credit period.
e. Firm A sells and installs carpeting; Firm B sells rugs
The firm that would probably have a longer credit period is A. Rugs are fairly
standardized and they are transportable anywhere, unlike carpets are custom fit and
are not particularly transportable.

4. If a company’s inventory carrying costs are Php 5 million per year and its fixed
order costs are Php 8 million per year, do you think the firm keeps too much inventory
on hand or too little? Why?
Answer: EOQ or the economic order quantity refers to the order quantity which will
give the lowest possible inventory costs for the company. Inventory costs are reduced
by minimizing both the ordering and carrying costs. In the given case, the ordering
cost is more than the carrying cost which means that the company is ordering lower
amounts of inventory and thus the order numbers are higher resulting in low
inventory. So the company should increase its inventory level to minimize the total
inventory costs.

5. At least part of Apple’s corporate profits can be traced to its inventory management.
Using just-in-time inventory, Apple typically maintains an inventory of three to four
days’ sales. Competitors such as Hewlett-Packard and IBM have attempted to match
Apple’s inventory policies, but lag far behind. In an industry where the price of PC
components continues to decline, Apple clearly has a competitive advantage. Why
would you say that it is to Apple’s advantage to have such a short inventory period? If
doing this is valuable, why don’t all other PC manufacturers switch to Apple’s
approach?
Answer: Apple’s approach to JIT is different in that they leverage their suppliers to
achieve JIT goals. Apple has only one central warehouse in the US and about 150 key
suppliers worldwide by developing strong and strategic relationship to their vendors.
This outsourcing of production made apple leaner and resulted in slashing costs and
reducing overstock. Most of their inventory is at their retail stores. Adding further to
the JIT mix, apple take advantage of the dropshipping for online orders. As a result,
this reduce shipping cost, wastage, and storage cost. Doing this is so much valuable,
PC manufacturers switching to apple’s approach is great but it requires knowledge
and expertise to achieve a clear competitive advantage.

Problems:

Problem 1

AlcoPlus Company sells on terms of net 45. Its annual credit sales are Php 912,500
and its accounts receivable average 15 days overdue. Assume a 365-day year. What is
Davis’ investment in receivables?
Answer:
Average Collection Period = 45 + 15 = 60 days
Average Sales = Php 912,500 = Php 2,500
365 days
Investment in Receivables = Php 2,500 x 60
= Php 150,000
Problem 2
Swift Musical Supply is not satisfied with its present credit policy. A proposal under
consideration is to change the credit terms from 1/10, net 30 to 2/10, net 30. The
firm’s current average collection period is 42 days but it is expected to decline to 38
days. The percentage of credit customers who take the discount is expected to
increase from 45 percent to 60 percent under the new policy. Credit sales are
anticipated to remain Php 400,000 with a contribution margin of 25 percent. The bad
debt losses are forecasted to decrease from 3.0 percent of credit sales to 2.5 percent.
The firm’s opportunity cost of investing in additional receivables is 18 percent. Should
Swift adopt this change in policy?
Answer:
Marginal Profits On Additional Sales = .25 x 0 = 0

Current Bad Debt Losses = Php 400,000 x .03 = Php 12,000

New Bad Debt Losses = Php 400,000 x .025 = Php 10,000

Reduction in Bad Debts Losses = Php 12,000 - Php 10,000 = Php 2,000

Current Average A/R Balance = (Php 400,000/365) (42) = Php 46,027.40

New Average A/R Balance = (Php 400,000/365) (38) = Php 41,643.84

Reduction in A/R investment = Php 46,027.40 - Php 41,643.84 = Php 4,383.56

Earnings on Funds = Php 4,383.56 x 0.18 = Php 789

Cost of Current Cash Discount = Php 400,000 x 0.45 x 0.01 = Php 1,800

Cost of New Discount = Php400,000 x 0.60 x 0.02 = Php 4,800

Cost of Increase in Cash Discount = Php 4,800 - Php 1,800 = Php 3,000

Net Advantage/Disadvantage of Changing Credit Terms

= (Php 0 + Php 2,000 + Php 789) - Php 3,000

= (Php 211)

 Swift Musical Supply should not adopt the change in their credit policy because
the change will result in their disadvantage or unfavorable terms.
Problem 3

RiRi Ice Cream sells 12,000 gallons of ice cream each month from its central storage
facility. Monthly carrying costs are Php 0.10 per gallon and ordering costs are Php 50
per order. Ignore potential stockout costs and assume a 30-day month.

Required:
a. What is the economic order quantity (EOQ) for the ice cream?
Answer:

EOQ = 2 x Annual demand in units x Cost per order (EOQ)

Carrying costs per unit

= 2 x 12,000 x 50
0.10

= 1,200,00
0.10

= 12,000,000

= 3,464.10 units

b. What is the average inventory?

Answer:
Average Inventory = EOQ or order size
2

= 3,464.10
2
= 1,732.05 units
c. What is the total inventory cost for the month?
Answer:
Total Inventory Cost = Total ordering costs + Total carrying costs

= 12,000 x 50 + 3,464.10 x .10

3464.10 2

= 3.46 x 50 + 1,732.05 x .10

= 173.21 + 173.21
= Php 346.42

d. What is the optimal length of the inventory cycle?

Answer:
Reorder point = Lead Time usage + Safety Stocks
= 12,000 x 30 + 0
50

= 240 x 30
= 7200 units

e. How many orders will be placed per month?

Answer:
Number of orders = 12,000
3464.10

= 3.46 orders per month

Problem 4

Fruitcake Specialists sells 36,000 fruit cakes annually. Annual carrying costs are Php
5 per fruit cake and the ordering costs are Php 100 per order. The firm has decided to
maintain a safety stock of one month’s sales or 3,000 fruitcakes. The delivery time per
order is 5 days. Assume a 365-day year.

Required:
a. What is the economic order quantity (EOQ)?
Answer:

EOQ = 2 x Annual demand in units x Cost per order (EOQ)

Carrying costs per unit

= 2 x 36,000 x 100
5

= 7,200,000
5

= 1,440,000

= 1,200 units

b. What is the average inventory?

Answer:
Average Inventory = EOQ or order size
2

= 1,200
2
= 600 units
c. How many orders should be placed each year?
Answer:
Number of orders = 36,000
1,200

= 30 orders each year

d. What is the total inventory cost?

Answer:
Total Inventory Cost = Total ordering costs + Total carrying costs

= 36,000 x 100 + 1,200 x 5

1,200 2

= 30 x 100 + 600 x 5
= 3,000 + 3,000
= Php 6,000

e. What is the reorder point?

Answer:
Reorder point = Lead Time usage + Safety Stocks
= 36,000 x 5 + 3,000
100

= 1,800 + 3,000
= 4,800 units