Financial Management

(B. Working Capital Management)

B. WORKING CAPITAL MANAGEMENT D. Increase the amount of equity financing.

Conservative
THEORIES: 2. As a company becomes more conservative with respect to working
Working capital management capital policy, it would tend to have a(n)
1. Working capital management involves investment and financing decisions A. Increase in the ratio of current liabilities to noncurrent liabilities.
related to: B. Increase in the operating cycle.
A. plant and equipment and current liabilities. C. Decrease in the operating cycle.
B. current assets and capital structure. D. Increase in the ratio of current assets to current liabilities.
C. current assets and current liabilities.
D. sales and credit. Moderate
3. Short-term financing plans with high liquidity have:
17. The goal of managing working capital, such as inventory, should be to A. high return and high risk
minimize the: B. moderate return and moderate risk
A. costs of carrying inventory C. low profit and low risk
B. opportunity cost of capital D. none of the above
C. aggregate of carrying and shortage costs
D. amount of spoilage or pilferage Temporary & Permanent working capital
4. Temporary working capital supports
Working capital financing policy A. the cash needs of the company. C. acquisition of capital equipment.
Aggressive B. payment of long term debt. D. seasonal peaks.
5. Zap Company follows an aggressive financing policy in its working capital
management while Zing Corporation follows a conservative financing Cash Management
policy. Which one of the following statements is correct? Motives for holding cash
A. Zap has low ratio of short-term debt to total debt while Zing has a 7. The transaction motive for holding cash is for:
high ratio of short-term debt to total debt. A. a safety cushion C. compensating balance
B. Zap has a low current ratio while Zing has a high current ratio. requirements
C. Zap has less liquidity risk while Zing has more liquidity risk. B. daily operating requirements D. none of the above
D. Zap finances short-term assets with long-term debt while Zing
finances short-term assets with short-term debt. Float
8. The difference between the cash balance on the firm's books and the
6. Which of the following would increase risk? balance shown on the bank statement is called:
A. Raise the level of working capital. A, the compensating balance C. a safety cushion
B. Decrease the amount of inventory by formulating an effective B. float D. none of the above
inventory policy.
C. Increase the amount of short-term borrowing. Cash conversion cycle

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9. The length of time between payment for inventory and the collection of
cash is referred to as: Inventory management
A. payables deferral period C. operating cycle 16. The use of safety stock by a firm will:
B. receivables conversion period D. cash conversion cycle A. reduce inventory costs C. have no effect on inventory costs
B. increase inventory costs D. none of the above
10. As a firm's cash conversion cycle increases, the firm:
A. becomes less profitable 18. When a specified level of safety stock is carried for an item in inventory,
B. increases its investment in working capital the average inventory level for that item
C. reduces its accounts payable period A. decreases by the amount of the safety stock.
D. incurs more shortage costs B. is one-half the level of the safety stock.
C. Increases by one-half the amount of the safety stock.
11. The longer the firm's accounts payable period, the: D. Increases by the number of units of the safety stock.
A. longer the firm's cash conversion cycle is.
B. shorter the firm's inventory period is. 19. Which of the following statements is correct for a firm that currently has
C. more the delay in the accounts receivable period. total costs of carrying and ordering inventory that are 50% higher than total
D. less the firm must invest in working capital. carrying costs?
A. Current order size is greater than optimal
12. The average length of time a peso is tied up in current asset is called the: B. Current order size is less than optimal
A. net working capital. C. receivables conversion period. C. Per unit carrying costs are too high
B. inventory conversion period. D. cash conversion period. D. The optimal order size is currently being used

Receivables management Trade credit

13. All of these factors are used in credit policy administration except:
A. credit standards C. peso amount of receivables
B. terms of trade D. collection policy
14. Which of the following statements is most correct? If a company lowers its
DSO, but no changes occur in sales or operating costs, then:
A. the company might well end up with a higher debt ratio.
B. the company might well end up with a lower debt ratio.
C. the company would probably end up with a higher ROE.
D. the company's total asset turnover ratio would probably decline.
15. All but which of the following is considered in determining credit policy?
A. Credit standards C. Accounts payable deferral period
B. Credit limits D. Collection efforts
20. With credit terms of 3/8, n/30, what is the customer’
date?
A. Three days after the invoice is received.
B. The 8th day is the customer’ .
C. Anytime during the period, 8th to the 30th.
D. The 30th day is the primary decision date.
PROBLEMS
Working capital financing
i. Casie Company turns out 200 calculators a day at a cost of P250 per
calculator for materials and variable conversion cost. It takes the firm 18
days to convert raw materials into calculator. Casie’
extended to its customers is 30 days, and the firm generally pays its
suppliers in 20 days.

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(B. Working Capital Management)

If the foregoing cycles are constant, what amount of working capital A. 50 days C. 120 days
must Casie Company finance? B. 90 days D. 40 days
A. P1,400,000 C. P 900,000
B. P2,400,000 D. P1,800,000 Cash management
Economic conversion quantity (ECQ)
Cash conversion cycle vii. Simile Inc. has a total annual cash requirement of P9,075,000 which are to
ii. Luke Company has an inventory conversion period of 60 days, a be paid uniformly. Simile has the opportunity to invest the money at 24%
receivables conversion period of 45 days, and a payments cycle of 30 days. per annum. The company spends, on the average, P40 for every cash
What is the length of the firm’ ? conversion to marketable securities.
A. 90 days C. 54 days What is the optimal cash conversion size?
B. 75 days D. 105 days A. P60,000 C. P45,000
B. P55,000 D. P72,500
iii. The Spades Company has an inventory conversion period of 75 days, a
receivables conversion period of 38 days, and a payable payment period Opportunity cost
of 30 days. What is the length of the firm’ ? viii. Hyperbole Corporation estimates its total annual cash disbursements of
A. 83 days C. 67 days P3,251,250 which are to be paid uniformly. Hyperbole has the opportunity
B. 113 days D. 45 days to invest the money at 9% per annum. The company spends, on the
average, P25 for every cash conversion to marketable securities and vice
iv. Samaritan Supplies, Inc. has P5 million in inventory and P2 million in versa.
accounts receivable. Its average daily sales are P100,000. The company What is the opportunity cost of keeping cash in the bank account?
has P1.5 million in accounts payable. Its average daily purchases are A. P3,825.00 C. P4,190.00
P50,000. What is the length of the company’ ? B. P1,912.50 D. P 188.55
A. 50 days C. 30 days
B. 20 days D. 40 days Annual savings
ix. What are the expected annual savings from a lock-box system that collects
Days inventory 150 checks per day averaging P500 each, and reduces mailing and
v. What is the inventory period for a firm with an annual cost of goods sold of processing times by 2.5 and 1.5 days respectively, if the annual interest
P8 million, P1.5 million in average inventory, and a cash conversion cycle rate is 7%?
of 75 days? A. P 5,250 C. P 21,000
A. 6.56 days C. 52.60 days B. P 13,125 D. P300,000
B. 18.75 days D. 67.50 days
Receivables management
vi. Samaritan Supplies, Inc. has P5 million in inventory and P2 million in Carrying cost
accounts receivable. Its average daily sales are P100,000. The company x. The Camp Company has an inventory conversion period of 60 days, a
has P1.5 million in accounts payable. Its average daily purchases are receivable conversion period of 30 days, and a payable payment period of
P50,000. What is the length of the company’ ? 45 days. The Camp’

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costs of P600,000. The current cost of capital for Camp is 12%. were made?
If Camp’ ,375,000 and all sales are on credit, what is A. P 9,688 C. P 96,875
the firm’ , using 360 days year? B. P 12,988 D. P129,975
A. P281,250 C. P 20,250
B. P168,750 D. P 56,250 Comprehensive
Question Nos. 14 through 16 are based on the following data:
Average receivables Sonata Company is considering changing its credit terms from 2/15, net 30 to
xi. Caja Company sells on terms 3/10, net 30. Total sales for the year are 3/10, net 30 in order to speed collections. At present, 40 percent of Sonata
P900,000. Forty percent of the customers pay on the tenth day and take Company‘s customers take the 2 percent discount. Under the new term,
discounts; the other 60 percent pay, on average, 45 days after their discount customers are expected to rise to 50 percent. Regardless of the credit
purchases. terms, half of the customers who do not take the discount are expected to pay
What is the average amount of receivables? on time, whereas the remainder will pay 10 days late. The change does not
A. P70,000 C. P77,200 involve a relaxation of credit standards; therefore bad debt losses are not
B. P77,500 D. P67,500 expected to rise above their present 2 percent level. However, the more
generous cash discount terms are expected to increase sales from P2 million
xii. Palm Company’ ,500,000 of to P2.6 million per year. Sonata Company’
which 80% are expected to be credit sales at terms of n/30. Palm estimates 75 percent, the interest rate on funds invested in accounts receivable is 9
that a proposed relaxation of credit standards will increase credit sales by percent, and the firm’ .
20% and increase the average collection period from 30 days to 40 days.
Based on a 360-day year, the proposed relaxation of credit to standards xiv. What are the days sales outstanding (DSO) before and after the change
will result in an expected increase in the average accounts receivable of credit policy?
balance of A. 27.0 days and 22.5 days, respectively C. 22.5 days and 21.5
A. P 540,000 C. P2,700,000 days, respectively
B. P 900,000 D. P1,620,000 B. 22.5 days and 27.0 days, respectively D. 21.5 days and 22.5
days respectively
Investment in receivables
xiii. Currently, La Carlota Company has annual sales of P2,500,000. Its
average collection period is 45 days, and bad debts are 3 percent of sales. xv. The incremental carrying cost on receivable is
The credit and collection manager is considering instituting a stricter A. P 843.75 C. P 643.75
collection policy, whereby bad debts would be reduced to 1.5 percent of B. P8,889.00 D. P6,667.00
total sales, and the average collection period would fall to 30 days.
However, sales would also fall by an estimated P300,000 annually. xvi. The incremental after tax profit from the change in credit terms is
Variable costs are 75 percent of sales and the cost of carrying receivables A. P68,493 C. P60,615
is 10 percent. Assume a tax rate of 40 percent and 360 days per year. B. P65,640 D. P57,615
What would be the decrease in investment in receivables if the change
Inventory management

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EOQ xx. For Raw Material L12, a company maintains a safety stock of 5,000
xvii. What is the economic order quantity for the following inventory policy: pounds. Its average inventory (taking into account the safety stock) is
A firm sells 32,000 bags of premium sugar per year. The cost per order is 12,000 pounds. What is the apparent order quantity?
P200 and the firm experiences a carrying cost of P0.80 per bag. A. 18,000 lbs. C. 14,000 lbs.
A. 2,000 bags C. 8,000 bags B. 6,000 lbs. D. 24,000 lbs
B. 4,000 bags D. 16,000 bags
Optimal safety stock level
Annual demand xxi. Each stockout of a product sold by Arnis Co. costs P1,750 per occurrence.
xviii. Marsman Co. has determined the following for a given year: The company’
Economic order quantity (standard order size) 5,000 units year, and the company orders 1,500 units of product 20 times a year at a
Total cost to place purchase orders for the year P40,000 cost of P100 per order. The probabilities of a stockout at various levels of
Cost to place one purchase order P 100 safety stock are:
Cost to carry one unit for one year P 4 Units of Safety Stock Probability of Stockout 0.
What is Marsman’ ? 0.50
A. 1,000,000 C. 500,000 100. 0.30
B. 2,000,000 D. 1,500,000 200. 0.14
300. 0.05
Required annual return on investment 400. 0.01
xix. BIBO Company is a distributor of videotapes. Pirate Mart is a local retail The optimal safety stock level for the company based on the units of
outlet which sells blank and recorded videos. Pirate Mart purchases tapes safety stock level above is
from BIBO Company at P300.00 per tape; tapes are shipped in packages A. 200 units C. 100 units
of 20. BIBO Company pays all incoming freight, and Pirate Mart does not B. 300 units D. 400 units
inspect the tapes due to BIBO Company's reputation for high quality.
Annual demand is 104,000 tapes at a rate of 4,000 tapes per week. Pirate xxii. Paeng Company uses the EOQ model for inventory control. The
Mart earns 20% on its cash investments. The purchase- order lead time is company has an annual demand of 50,000 units for part number 6702 and
two weeks. has computed an optimal lot size of 6,250 units. Per-unit carrying costs and
The following cost data are available: stockout costs are P9 and P4, respectively. The following data have been
Relevant ordering costs per purchase order P80 P90.50 gathered in an attempt to determine an appropriate safety stock level:
Carrying costs per package per year 3

Relevant insurance, materials handling, breakage, etc., per year 2 Units Short Because of Excess Number of Times Short
P 4.50 Demand during the Lead Time in the last 40 Reorder Cycles
What is the required annual return on investment per package? Period
100 8
A. P6,000 C. P1,200 200 10
B. P 250 D. P 600 300 14
400 8
Order quantity

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What is the optimal safety stock level? B. P135,000 D. P264,000

A. 100 units C. 200 units
B. 300 units D. 400 units Trade credit
xxvi. If a firm is given a trade credit terms of 2/10, net 30, then the cost to
Annual inventory costs the firm failing to take the discount is:
xxiii. Durable Furniture Company uses about 200,000 yards of a particular A. 2.0%. C. 36.7%
fabric each year. The fabric costs P25 per yard. The current policy is to B. 30.0%. D. 10.0%.
order the fabric four times a year. Incremental ordering costs are about
P200 per order, and incremental carrying costs are about P0.75 per yard, xxvii. The cost of discounts missed on credit terms of 2/10, n/60 is
much of which represents the opportunity cost of the funds tied up in A. 2.0 percent C. 12.4 percent
inventory. B. 14.9 percent D. 21.2 percent
How much total annual costs are associated with the current inventory
policy? Bank loans
A. P19,550 C. P38,300 Discount loan
B. P18,750 D. P62,500 xxviii. You plan to borrow P10,000 from your bank, which offers to lend you
the money at a 10 percent nominal, or stated, rate on a one-year loan. What
Maximum interest rate is the effective interest rate if the loan is a discount loan?
xxiv. Narra Company is considering a switch to level production. Cost A. 10.00% C. 12.45%
efficiencies will occur under level production and after tax cost would B. 11.11% D. 14.56%
decline by P70,000 but inventory would increase from P1,000,000 to
P1,800,000. Narra would have to finance the extra inventory at a cost of Discount loan with compensating balance
10.5 percent. xxix. What is the effective rate of a 15% discounted loan for 90 days,
What is the maximum interest rate that makes level production feasible? P200,000, with 10% compensating balance? Assume 360 days per year.
A. 7.00 percent C. 8.75 percent A. 20.0% C. 17.4%
B. 5.83 percent D. 10.00 percent B. 15.0% D. 22.2%

Opportunity cost Compensating balance with interest

xxv. Diesel Fashion estimates that 90,000 zippers will be needed in the xxx. The Premiere Company obtained a short-term bank loan for
manufacture of high selling products for the coming year. Its supplier P1,000,000 at an annual interest rate 12%. As a condition of the loan,
quoted a price of P25 per zipper. Diesel planned to purchase 7,500 units Premiere is required to maintain a compensating balance of P300,000 in
per month but its supplier could not guarantee this delivery schedule. In its checking account. The checking account earns interest at an annual rate
order to ensure availability of these zippers, Diesel is considering the of 3%. Premiere would otherwise maintain only P100,000 in its checking
purchase of all these 90,000 units on January 1. Assuming Diesel can account for transactional purposes. Premiere’
invest cash at 12%, the company’ interest costs of the loan is
90,000 units at the beginning of the year is A. 12.00% C. 16.30%
A. P127,500 C. P123,750 B. 14.25% D. 15.86%

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following loan proposal:

Add-on • Stated interest rate of 10% on a one-year discounted loan; and
xxxi. Perlas Company borrowed from a bank an amount of P1,000,000. The • 15% of the loan as compensating balance on zero-interest current
bank charged a 12% stated rate in an add-on arrangement, payable in 12 account to be maintained by Island Corporation with Peninsula
equal monthly installments. Commercial Bank.
A. 22.15% C. 25.05% The loan requires a net proceeds of P1.5 million. What is the principal
B. 24.00% D. 12.70% amount of loan applied for as part of the loan agreement?
A. P1,666,667 C. P1,764,706
Financing alternative B. P2,000,000 D. P1,125,000
xxxii. A company has accounts payable of P5 million with terms of 2%
discount within 15 days, net 30 days (2/15 net 30). It can borrow funds from
a bank at an annual rate of 12%, or it can wait until the 30th day when it
will receive revenues to cover the payment. If it borrows funds on the last
day of the discount period in order to obtain the discount, its total cost will
be
A. P 51,000 less C. P 75,500 less
B. P100,000 less D. P 24,500 more

xxxiii. Every 15 days a company receives P10,000 worth of raw materials from
its suppliers. The credit terms for these purchases are 2/10, net 30, and
payment is made on the 30th day after each delivery. Thus, the company
is considering a 1-year bank loan for P9,800 (98% of the invoice amount).
If the effective annual interest rate on this loan is 12%, what will be the net
peso savings over the year by borrowing and then taking the discount on
the materials?
A. P3,624 C. P4,800
B. P1,176 D. P1,224

xxxiv. An invoice of a P100,000 purchase has credit terms of 1/10, n/40. A

bank loan for 8 percent can be arranged at any time. When should the
customer pay the invoice?
A. Pay on the 1st. C. Pay on the 40th
B. Pay on the 10th D. Pay on the 60th

xxxv. The Peninsula Commercial Bank and Island Corporation agreed to the

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Less: Ave. Accounts Payable payment days (1.5M/0.5M)30.0 days

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