Financial Management

KAPALONG COLLEGE OF AGRICULTURE, SCIENCES AND TECHNOLOGY
FINANCIAL
MANAGEMENT
FM 101
1ST SEMESTER 2020-2021 ESTRELLIETA R. OLAER

BSBA Instructor
Financial Management 1
COURSE OVERVIEW
Financial Management
This course pack covers the basic concepts and techniques in finance that will
be use by the learners to develop finance literacy. It focuses on the core principles of
finance from the investor point of view- who is seeking to make sound business
choices and management point of view-trying to maximize the value of the firm.
Finance is the lifeblood of business organization. It is difficult for organizations,

whether profit-making or otherwise, to sustain themselves for long without proper
finances. Financial management helps the management to do so. This course provides
the students to make personal and corporate appropriate financial strategies.
In order for learners to gain competency in this course, this course pack has
been structured into four modules as follows.
Module 1: Fundamental Concepts in Financial Management and Financial

Forecasting
Module 2: Financial Assets and Time Value of Money
Module 3: Investing in Long-Term Assets: Capital Budgeting

Module 4: Working Capital Management
At the completion of this course pack, learners should be able to:
• Apply concepts and techniques in finance in evaluating financial

performance and assessing financial requirements.
• Prepare the basic financial statements of a corporate business and master
budget needed in strategic planning.
• Learn how to manage working capital to meet short-term financing needs
of the firm.
Careful consideration was given to the sequencing of the lessons, hence,

learners in this course are encouraged to go through each lesson in every module
sequentially to maximize their learning. Examples, illustrative cases and figures
throughout the course pack have been included to enhance the understanding of the
lessons.
So, to make this learning experience rewarding for you, study this course pack
with your co-learners at your own pace. You can also ask the help and support of your
peers, tutor and friends.
God Bless.
Table of Contents
Module 1: Fundamental Concepts in Financial Management and Financial Forecasting

Module Overview
Lesson 1: Overview of Financial Management
Lesson 2: Financial Statements and Long-Term Financial Planning
Lesson 3: Analysis of Financial Statements
Lesson 4: Financial Forecasting, Corporate Planning and Budgeting
Module 2: Financial Assets and Time Value of Money
Module Overview
Lesson 1: Interest Rates
Lesson 2: Time Value of Money
Module 3: Investing in Long-Term Assets
Module Overview
Lesson 1: Cost of Capital
Lesson 2: Basics of Capital Budgeting
Module 4: Working Capital Management
Module Overview
Lesson 1: Working Capital
Lesson 2: Working Capital Management
Module 1
Fundamental Concepts in Financial Management and
Financial Forecasting
Module Overview:
In this module:
• Overview of Financial Management
• Financial Statements and Long-Term Financial Planning
• Analysis of Financial Statements
• Financial Forecasting, Corporate Planning and Budgeting
In Module 1, you will learn that the primary goal of financial management is to
help managers maximize their firms' values, subject to constraints such as not
polluting the environment, not engaging in unfair labor practices, and not engaging in
antitrust activities. In lesson 1, the concept of valuation, explain how it depends on
future cash flows and risk, and show why value maximization is good for society in
general will be introduced. The valuation theme runs throughout the module. Asset
values depend in a fundamental way on earnings and cash flows as reported in the
accounting statements hence you review those statements in lesson 2. Then in lesson
3 & 4, you will learn how accounting data can be analyzed and used to measure how
well a company has operated in the past and how it is likely to perform in the future.
After the completion of this module, you should be able to:
• Explain the definition of finance and the six principles of finance
• Analyze the basic financial statements using various financial ratios to
assess the firm’s financial performance
• Understand the importance of corporate planning to attain the goal of
financial management.
• Prepare a master budget.
Are you ready? Then start the lessons now!
MODULE 1, LESSON 1
OVERVIEW OF FINANCIAL MANAGEMENT
OBJECTIVES
At the end of the module, the students should be able to:
a. explain the definition and evolution of finance as a recognized field of study;

b. describe the nature, scope and goals of financial management; and
c. discuss the importance of financial management and ethics in finance.
Time Frame This lesson is expected to be finished in 1 week
INTRODUCTION
Financial management is one of the most important responsibilities of owners

and financial managers. They must consider the potential consequences of their
management decisions on profits, cash flow and on the financial condition of the
company. The activities of every aspect of a business have an impact on the
company's financial performance and must be evaluated and controlled.
This lesson will give you an idea on the nature, purpose and scope of financial
management. It begins by describing how finance is related to the overall business
and by discussing the different forms of business organization. It will also help you to
understand the role of financial manager and the importance of corporate governance
in in achieving the primary goal of the firm.
Enjoy and keep reading!
Activity
Task 1:
Suppose you are starting your own No. Role Importance
business, think of specific roles that you 1.
will be acting in managing your business 2.
successfully. List 5 specific roles and
3.
indicate the importance of the role listed
in your business. Write your answer in 4.
your notebook. 5.
Task 2:
Picture yourself as potential financial manager five years from now, what should you
do now to equip yourself with the necessary tools? (Answer the question in not less
than 50 words)
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Note: The following answers will be graded based on the set criteria:
Content (5 pts), Relevance and Accuracy (3pts.), Organization of thoughts (2 pts.) Total of 10pts.
Analysis
Task 3. Answer the following question and write your answer on space given.
(Individual Activity)
1. What is meant by goal maximization of the shareholder’s wealth?
Answer:
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2. What are the functions of financial management and responsibilities of a

financial manager?
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3. Compare and contrast the different forms of business organizations.

Why is a corporation more suitable for large organizations?
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4. What issue does Agency Relationships theory examine?

Answer:
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5. Can our goal of maximizing the value of the equity shares conflict with
other goals, such as avoiding unethical or illegal behavior? In particular,
do you think subjects like customer and employee safety, environment
and general good of society fit in this framework, or are they essentially
ignored? Think of some specific scenarios to illustrate your answer.
Answer:
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Abstraction
The primary goal of the Management is to maximize the shareholder’s wealth, which
means maximizing the true, long-run value of the stock. In maximizing the value of the
stocks, the firm makes developments in terms of products and services which suit the
wants of the consumer, provided it was sold at a competitive price. If the maximization
of value of the stocks is successful then people will benefit from it in different ways.
The essential tasks of the CFO are to make sure the accounting system provides
"good" numbers for internal decision making for investors, to ensure that the firm is
financed in proper manner, to evaluate the operating units to make sure they will
increase the firm's value.
Business organizations have four main forms it can be proprietorships, partnerships,
corporations, limited liability companies (LLLC’s), or limited liability partnerships
(LLP’s). By far most of all business is finished by corporations, and the best firms get
to be corporations, which clarifies the focus on organizations in this book. It also
discussed three important business trends which are changing the way business is
done. And these are the trend toward globalization, the ever-improving information
technology, and the changes in corporate governance.
A proprietorship, or sole proprietorship, is a business owned by one individual. A
partnership exists when two or more persons associate to conduct a business. In
contrast, a corporation is a legal entity created by a state. The corporation is separate
and distinct from its owners and managers.
In a limited partnership, limited partners’ liabilities, investment returns and control are
limited, while general partners have unlimited liability and control. A limited liability
partnership (LLP), sometimes called a limited liability company (LLC), combines the
limited liability advantage of a corporation with the tax advantages of a partnership. A
professional corporation (PC), known in some states as a professional association
(PA), has most of the benefits of incorporation but the participants are not relieved of
professional (malpractice) liability.
Sole proprietorship, partnership, and corporation are the three principal forms of
business organization. The advantages of the first two include the ease and low cost
of formation. The advantages of the corporation include limited liability, indefinite life,
ease of ownership transfer, and access to capital markets. The disadvantages of a
sole proprietorship are (1) difficulty in obtaining large sums of capital; (2) unlimited
personal liability for business debts; and (3) limited life. The disadvantages of a
partnership are (1) unlimited liability, (2) limited life, (3) difficulty of transferring
ownership, and (4) difficulty of raising large amounts of capital. The disadvantages of
a corporation are (1) double taxation of earnings and (2) requirements to file state and
federal reports for registration, which are expensive, complex and time-consuming.
Stockholder wealth maximization is the appropriate goal for management decisions.
The risk and timing associated with expected earnings per share and cash flows are
considered in order to maximize the price of the firm’s common stock.
Social responsibility is the concept that businesses should be partly responsible for,
and thus bear the costs of, the welfare of society at large. Business ethics can be
thought of as a company’s attitude and conduct toward its employees, customers,

community, and stockholders. A firm’s commitment to business ethics can be
measured by the tendency of the firm and its employees to adhere to laws and
regulations relating to such factors as product safety and quality, fair employment
practices, and the like.
An agency problem arises whenever a manager of a firm owns less than 100 percent
of the firm’s common stock, creating a potential conflict of interest called an agency
conflict. The fact that the manager will neither gain all the benefits of the wealth
created by his or her efforts nor bear all of the costs of perquisite consumption will
increase the incentive to take actions that are not in the best interests of the
nonmanager shareholders.
A hostile takeover, when management does not want the firm to be taken over, is most
likely to occur when a firm’s stock is undervalued relative to its potential because of
poor management. The managers of the acquired firm are generally fired or lose the
autonomy they had prior to the acquisition.
Profit maximization is merely maximizing the net income (earnings) of the firm.
Because of factors such as risk, timing of earnings, number of shares outstanding,
and so on, profit maximization does not necessarily lead to stockholder wealth
maximization.
Application
Task 4.
Direction: using your creativity, draw a concept map or paradigm that illustrates the
concepts of:
1. Goals of Financial Management
2. Agency Relationships
3. Functions of Financial Management
Reflection
Task 5. Direction: Write the things you learned in this module by completing the
blanks. Your answer must not less than 50 words.
I have learned that Financial Management
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I have realized the importance of Financial Management
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I will apply in my future business

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Great! You have just completed the activities and tasks for the lesson 1. It is
expected that you have gained insights and meaningful experience in the
lesson. Now, you are already prepared to move to lesson 2 of this module. So?
Enjoy and keep working!
MODULE 1, LESSON 2
Financial Statements and Long-Term Financial
Planning
OBJECTIVES
At the end of the module, you should be able to:
a. explain the definition and components of financial statements;

b. explain the relationship of the components of financial statements;
c. prepare the basic financial statements
INTRODUCTION
Preparing financial statements, including the Statement of Financial Position,
Income statement, and Statement of Shareholder’s equity is the most important step
in the accounting cycle because it represents the purpose of financial accounting.
These statements are the end products of the accounting system in any company. Its
foremost objective is to provide information concerning the financial position,
performance and cash flows of a company needed by various users in making sound
economic decisions.
This lesson provides you the accounting process necessary to prepare financial
statements for a corporation. This will also serve as a review, or for some, a preview
of Fundamentals of Accounting subject in the proper procedures in preparing financial
statements at the end of the fiscal period for a corporation.
Learning Tasks
A R E A E R A H S Y R U S A E R T A R
I N K P R E F E R R E D S H A R E O E
N N O O C T O B E R P U R C H A S E L
V O C N I A C C R U E D E X P E N S E
E T O O P I C A R E P A B N S T E R M
N E M I M N C S L Q B P A O D O P E O
T S M T F E O H A A I W L A N D X N C
O P O A A D S O U L N A A I I B E T N
R A N I L E T T R I E B N O J U D E I
Y Y S C L A O S A T T S C G A T I X R
C A H E P R F B O T H E E E B I A P E
O B A R F N S E O R E R S A I J P E H
V L R P I I A L D D I M H H K L E N T
I E E E G N L M A D E E E R B A R S O
D I E D S G E B E E F E E N D S P E S
I N Y C O S S O F S A T T I T O L B H
Task 1:
Find and circle all of the 16 Accounting related words that are hidden in the grid. The
words may be hidden in any direction.
1. ____________________ 9. ___________________
2. ____________________ 10. _____________________
3. ____________________ 11. _____________________
4. ____________________ 12_____________________
5. ____________________ 13_____________________
6. ____________________ 14_____________________
7. ____________________ 15. _____________________
8. ____________________ 16. _____________________
Task 2:
From the words found in the grid, identify if it is an Income Statement or a
Statement of Financial Position account. What form of business organization used
this Account Titles?
Income Statement Account Statement of Financial Position account
Analysis
Task 3. Answer the following questions. Your answers must not less than 50
words. (Individual Activity)
1. What is the relationship of the components of financial statements?
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2. What is the nature and significance of financial statements?

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Abstraction
Accounting is the basic language of business. Hence, it is used to track or to configure
the financial performance of a business. This was done through financial statements
and reports which give the investor an overview of what are the current status of the
business. Corporations issue annual report which is the most essential report given to
the stockholders. It contains quantitative and verbal information. Verbal information
which is typically a letter describing the results of the operations while the Quantitative
information includes the four basic financial statements: balance sheet, income
statement, statement of cash flows and statement of stockholder’s equity. Both
quantitative and verbal materials are important. The financial statements emphasize
what happened to the business’s assets, liabilities and capital that comes with a
quantitative data over the past few years, whereas the verbal statements explain why
things turned out that way and states what will probably happen in the future.
Application
Task 4
1. From the account balances given below for Surf Corp., you are tasked to
prepare the statement of financial position. Observe the proper classifications.
In thousand pesos.
Accounts Receivable P 400
Advances to Officers not currently collectible 100
Sinking Fund 400
Building 5,000
Long-term refundable deposit 50
Cash and cash equivalent 560
Equipment 1,000
Lease rights 100
Accrued interest income 10
Inventories 1,300
Land 2,000
Notes Receivable 250
Computer Software 3,250
Prepaid expenses 70
Trading securities 280
Unearned rent income 40
Retained earnings 1,800
Share premium 500
Premium on bonds payable 1,000
Preference share capital 2,000
Share premium-ordinary 200
Notes payable 3,000
SSS payable 10
Accounts payable 400
Accrued salaries 100
Accumulated depreciation-building 2,000
Accumulated depreciation-equipment 200
Allowance for doubtful accounts 20
Bonds payable 5,000
Dividends payable 120
Ordinary share capital 5,350
Withholding tax payable 30
2. Based on the audited financial statements of Pilipinas Share Petroleum

Corporation given below, thoroughly discuss your observations on the
financial statements. Your discussions can focus on the following:
2.1 What financial statements are reported by the company?
2.2 On the statement of Financial Position (SFP):
2.2.1 The preparation and classification used in the presentation of the
SFP; and
2.2.2 The accounts included in the SFP
2.3 On the Income Statement:
2.3.1 The form of the Income Statement used by the company; and
2.3.2 The accounts and the arrangement as presented in the income
statement;
2.4 On the Statement of Changes in Equity:
2.4.1 Discuss how the statement was presented
2.4.2 What items worth noting were included in the statements?
2.5 On the Cash Flow Statement:
2.5.1 Discuss how the cash flow statement presented
2.5.2 What items worth noting were included in the statements?
2.6 On the Notes of Financial Statements:
2.6.1 Discuss the outline in the presentation of the notes to Financial
Statements.
2.6.2 What salient items are worth noting in the preparation of the notes
to financial statements?
(Note: Please keep the financial statements in this module. You will still be
using them for the next module.)
Reflection
Task 5. Direction: Write the things you learned in this module by completing the
blanks. Your answer must not less than 50 words.
I have learned that Financial Statements

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I have realized that the importance of Financial Statements
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I will apply in my long-term planning
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Well done! You have just finished lesson 2 of this module. Should there be some
parts of the lesson which you need clarification, write your questions/concerns in our
GC.
Now if you’re ready, you may proceed to lesson 3 of this module. So, have fun and
keep reading!
MODULE 1, LESSON 3
Analysis of Financial Statements
OBJECTIVES
a. explain the various ways financial statements are analyzed;

b. understand the objectives and limitations of financial statements analysis;
c. understand the steps in doing financial statement analyses; and
d. perform the steps in doing financial statement analyses by applying the
different techniques, interpretations, conclusions, and draw the
implications based on the results of the application.
INTRODUCTION
Financial statements are basically an information an outsider can derive from

the company. To be able to assess the different aspects of the enterprise, (such as
asset management, profitability, and performance), a financial statement analysis can
be made. It interprets financial statement data and presents in summary form to
simplify user’s analysis.
This lesson continues to look at the role of financial documents in investment
analysis. Using the three main financial statements (income statement, balance sheet,
statement of cash flow), you will be introduced to analysis of financial ratios and
longitudinal evaluation of financial data. In this lesson, you will learn how to calculate
different financial ratios and do longitudinal evaluation (horizontal, vertical and trend
analysis) to better understand a firm’s liquidity, operating efficiency, and risk.
Learning Tasks
Fundamentally, analyses of financial statements are set to answer a wide-range of
questions of users. These users have diverse concerns, and objectives. Hence, they
have different priorities. However, all these users have common requirements where
the very objective of financial statements analyses originate.
Task 1. Direction: Study the scrambled letters and try to rearrange the letters to
form a word related to diverse concerns of financial statement users. (Individual
Activity)
1. BIFORPLATIYTI _______________________
2. DUTYIQIIL _______________________
3. TABILISYT _______________________
4. SEATS LIZTANOTIIU _______________________
5. BETD NOZILITUITA _______________________
Task 2. After answering task 1, define each word and indicate its importance to
the various users of financial statements. Make your answer is brief but concise.
Write your answer in the space provided below.
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Analysis
Task 3. Answer the following question and write your answer on the space
provided. (Individual Activity)
1.Why do you think most long-term financial planning begins with sales
forecasts? Put differently, why are future sales the key input?
Answer:
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2.Certain liability and net worth items generally increase spontaneously with
increase in sales. Put a cross (x) by those items that typically increase
spontaneously.
Answer:
Accounts payable _________
Notes payable to banks______
Accrued wages________
Accrued taxes _______
Mortgage bonds ______
Common stock _______
Retained earnings _______
3. Why is budgeting essential in managing the financial affairs of a business?
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3. In the previous module, you have reviewed financial statements prepared by

business organization. The main purpose of financial statements is to guide
users in making informed, prudent, or sound economic decisions. However,
prior to making decisions, an essential process must be done. In your words,
how can you make a thorough analyses of the information found in the financial
statements?
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Abstraction
Financial analysis involves comparing the firm’s performance to that of other firms in
the same industry and assessing trends in the firm’s financial position over time. With
these, managers can extract the problems or deficiencies that are needed to be
corrected and solved. To execute the analyzation, ratios are used to distinguish the
weakness and the things needed to improve. Ratios are grouped into five categories:
liquidity, asset management, debt management, profitability, and market value.
The firm's ratios are paralleled with averages for its industry and with the prominent
firms in the industry (benchmarking), and these correlations are utilized to figure
polices that will prompt enhanced future execution. Compare to other ratios, ROE is
the most important ratio since other ratios affect the value or the outcome of it.
Furthermore, DuPont equation is a tool used to show how ROE is determined. It also
identifies and explains the problem occurring if the ROE is lower than the benchmark
or the industry’s average.
Application
Task 4.
Direction: As previously noted in module 2, you were asked to keep the financial
statements given.
Requirements:
1. You are tasked to make a deeper look on the financial statements by making
a financial statement analysis. You may use the following format in answering:
Write you answer in another sheet of paper showing the format given below.
a. On Horizontal Analysis
Horizontal Analysis Computation (10 points)
Analysis and interpretation of your findings (5 points)
Conclusion (5 points)
Draw the implications to management (5 points)
State your recommendations (5 points)
b. On Vertical Analysis (Common-size statements)
Vertical Analysis Computation (10 points)
Analysis and interpretation of your findings (5 points)
Conclusion (5 points)
Draw the implications to management (5 points)
State your recommendations (5 points)
c. Ratios used to gauge asset management efficiency and liquidity
(used all ratios found in the matrix which is applicable to the company)
Computations (3 points per ratio calculated)
Discussion of your analysis and interpretation of the results (5 points)
Conclusions (5 points)
Implications to the management (5 points)
d. Ratios used to gauge a firm’s utilization of debt and company stability
e. Ratios used to gauge a firm’s profitability and return to owners.
Reflection
Task 5.
Direction: Write the things you learned in this module by completing the blanks. Your
answer must not less than 50 words.
I have learned that analysis of Financial Statements

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I have discovered the use of Vertical and Horizontal analysis as well as Ratio analysis
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I will apply in my future business

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Congratulations! You have successfully completed the activities and tasks for lesson
3.
Now, you are already prepared to move to lesson 4 of this module. So? Enjoy and
keep working!
MODULE 1, LESSON 4
Financial Forecasting,
Corporate Planning
and Budgeting
OBJECTIVES

1. understand the basic concepts involving financial forecasting, corporate
planning and budgeting;
2. explain what pro-forma financial statements and percent-of-sales method
are;
3. construct pro-forma statements in designing a financial forecast; and
4. apply percent-of-sales method in designing a financial forecast.
INTRODUCTION
In order for a business entity to thrive in a highly competitive environment, it is
essential that a financial manager must be able to plan ahead. Management must be
flexible and make adjustments in the company before relevant events (inflation,
deflation, recession, or new competition). To maximize the entity’s operations,
meticulous, and thorough planning is indispensable. Planning entails the creation of
both short-range and long-range objectives as well as seasonal financial targets.
These financial targets or objectives are the bases for developing the company’s
financial plans. Said financial plans shall function as a beacon that would guide
company operations. In addition to this, the plans serve as a control mechanism or
barometer to which results of operations shall be measured. Lastly, the financial plans
will serve as guides in taking corrective measures when needed.
This lesson shall present a basic or simplified version on how budgeting and
forecasting are done. A deeper presentation or discussion of these topics is presented
in higher Financial Management subject.
Activity
Task 1.
1. What are your major purchases (ex. Cellphone, laptop, bags) you plan to
make from August to December this year? List down your major purchases
below. To make your major purchases a reality, what will you do? (Answer the
question in not less than 50 words)
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Task 2.
2. Record in your notebooks what you have spent money on over the last two
days. (Have they bought any food, clothing or electronics? Have you gone to
the movies with a friend or bought any food?). Then, label your purchases as
fixed or variable expenses.
Purchases Fixed or variable

1.
2.
3
4.
5.
Analysis
Task 3.
Answer the following questions and write your answer on your notebook.
1. Why do you think most long-term financial planning begins with sales
forecasts? Put differently, why are future sales the key input?
Answer:
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2. What are the basic benefits and purposes of developing pro-forma statements
and cash budget
Answer:
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3. How is the collection and purchases schedules are related to the

borrowing needs of the corporation?
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Abstraction
Financial planning is often called value-based management which means that the
effects of various decisions on the firm’s financial position and value are studied by
simulating their effects within the firm’s financial model. There are four steps that
involve the financial plan: (1) assumptions are made about the future levels of sales,
costs, interest rates, and so forth, for use in the forecast; (2) a set of projected financial
statements is developed; (3) projected ratios, (4) the entire plan is reexamined, the
assumptions are reviewed, and the management team considers how additional
changes in operations might improve results.
Forecasting techniques are used by both investors and corporations to value a
company’s stock ; to estimate the benefits of potential projects; and to estimate how
changes in capital structure, dividend policy, and working capital policy.
The type of forecasting is important because management can formulate plans once
the projected operating resulted to unsatisfactory. Moreover, it helps the firm to know
if their money or accounts are sufficient for their operations which help them to prepare
for the future occurrences. It also gives guidance to the investors for financial analysis
regarding future earnings.
Application
Task 4. Direction: Show all computations in good form.
1. Sales of SciFi Corp are expected to be P 6,000 units for the month. The
company would like to maintain 15% of unit sales for each month in ending
inventory. Beginning inventory is 1,200 units. How many units should the
company produce for the coming month?
2. Meridian Company has a beginning inventory of 28,000 units. They intend

to sell 100,000 units for the current month and they wish to reduce ending
inventory to 40% of beginning inventory. How many units should the
company produce?
3. Kuvid Company has forecast credit sales for the fourth quarter of the year:
September (actual) P 100,000
Fourth Quarter
October 80,000
November 70,000
December 120,000
Based on past experience, 20% of sales are collected in the month of
sales, 70% in the following month and 10% are never collected.
Prepare a schedule of cash receipts for the company covering the last
quarter of the year.
4. Creatively draw a paradigm that maps the concepts on

a. Company budgeting
b. Preparation of Master Budget
Reflection
Task 5
I have learned that Financial Forecasting, Corporate Planning and Budgeting

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I have discovered the importance of master budget preparation

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CONGRATULATIONS! You have just finished this module. Now, you are ready
to take the Post-assessment of this Module. Are you ready? You may start
answering. Good Luck!
Post Assessment
Task 6
Directions: Read each item carefully. Then, encircle the letter of the correct
answer. For questions involving problem-solving, write your solution in the given box.
1. A high inventory turnover may indicate
a. a high risk of stock-outs.

b. an efficient use of the investment in inventory.
c. a low profit margin.
d. Both selections (a) and (c) are correct.
2. Inventory is removed from liquid assets in the calculation of the quick ratio
because
a. inventory is meaningless.
b. it is usually the least liquid of the current assets.
c. because it is a large part of current assets.
d. because it cannot be sold for cash.
3. Total asset turnover is
a) the ratio of net sales to total assets.
b) the ratio of net income to total assets.
c) the ratio of the cost of goods sold to total assets.
d) high.
4. The net profit margin
a) is less than or equal to the operating profit margin.
b) is less than or equal to the gross profit margin.
c) is greater than the operating profit margin.
d) Both selections (a) and (b) are correct sentence.
5. The debt-to-equity ratio is a measure of a firm's
a) financial leverage c. liquidity
b) operating leverage d. d) profitability
6. A company with a debt-to-equity ratio of 2.5 and P10 million of assets has
debt of
a) P2.9 million c. P7.14 million
b.) P5 million d. P8.23 million
7. A current ratio of 2.0
a. tells us that current assets are twice current liabilities.
b. is good.
c. indicates a problem with liquidity.
d. is greater than the quick ratio for a firm.
8. When an accountant calculates different parts of a financial statement in
terms of a percentage of the total amount, the accountant is doing a _____.
a. Horizontal analysis c. ratio analysis
b. vertical analysis d. financial statement
9. To measure liquidity, you can focus more closely on the working capital
items of the statement of _____
a. financial position c. financial analysis
b. financial performance d. financial equity
10. Which of the following is an example of debt utilization ratio?
a. Current ratio c. Inventory turnover ratio
b. Debt to equity ratio d. Accounts receivable collection
period.
11. A budget is not
a. A forecast c. a part of strategic management process
b. A qualitative statement d. a plan
12. In a manufacturing company, which budget is the first to be prepared in
the budget process?
a. the capital expenditure budget c. cash flow budget
b. the sales budget d. production budget
13. Which of the following does not help to minimize the problems
encountered in budgeting?
a. identifying the responsibility for key performance areas
b. keeping bad news from the managing director
c. ensuring adequate budget planning
d. encouraging manager participation
14. Which of the following is not obtained in the cash budget?
a. Depreciation c. purchases
b. Receipts d. payments
15. In preparing quarterly budget estimates, who should be responsible for the
cash budget?
a. Sales budget c. Finance manager
b. Production manager d. General Manager
16. Sometimes called as capex planning
a. operational planning c. corporate planning
b. project planning d. strategic planning
17. This involves the creation of strategies that are aimed in maximizing the
entity’s future position.
a. operational planning c. corporate planning
b. project planning d. strategic planning
18. Bull Company budgeted sales on account of P 120,000 for July, P 211,000
for August and P 198,000 for September. Collection experience indicates that
60% of the budgeted sales will be collected the month after the sale, 36% the
second month and 4% will be uncollectible. The cash from the accounts
receivable that should be budgeted for September would be
a. P 169,800 c. P 197,880
b. P 194,760 d. P 198,600
19. Based on potential sales of 500 units per year, a new product has estimated
traceable costs of P 900,000. What is the target price to obtain a 15% profit margin on
sales?
a. P 2,329 c. P 1,980
b. P 2,107 d. P 1,935
20. Which of the following best describes tactical profit plans?

a. Detailed, short-term, broad responsibilities, qualitative
b. Broad, short-term, responsibilities at all levels, quantitative
c. Detailed, short-term, responsibilities at all levels, quantitative
d. Detailed, long-term, broad responsibilities, qualitative
Direction: Write T if the statement is true and F if the statement is false.
___21. Shareholder wealth maximization means maximizing the price of the existing
common stock.
___22. Wealth maximization is superior to the profit maximization because the main
aim of the business concern under this concept to improve the value of wealth of the
board of directors.
___23. The financial manager may not be aware of the operational process and
finance required for each process of production activities.
___24. Financial management is an integral part of overall management. It is
concerned with the duties of the financial managers in the business firm.
___25. The firm's profit margin is the ultimate measure of performance in a business
organization.
___26. Partnership is the simplest form of business organization.
___27. Social responsibility is an issue that need to be considered in financial
management.
___28. Profit maximization does not fully take into account the timing when the
profit/gain would be received.
___29. The responsibilities of a financial manager are closely linked with the function
of financial management.
___30. Changes in profit may also mean changes in risk.
Directions: Unscramble each jumbled arrangement letter to form words missing in
the sentence.
____________31. The _______ sheet will report the total amount of a corporation's
retained earnings. NABCALE
____________32. The financial statement that reports the liabilities is sometimes
known as the statement of financial ____________. NIPIOOTS
____________33. The balance sheet reports amount at a _________ in time.
TIPNO
____________34. The amount of working __________ can be calculated quickly
from a classified balance sheet. TACLIPA
____________35. The income statement reports amounts for a _________ of time.
ORPIDE
____________36. The amounts earned from a company's main activities.
NEREVSEU
____________37. The costs that are matched with revenues. SENESEPX
____________38. Sales minus the cost of goods sold equals _______ profit.
SOGSR
____________39. The financial statement that reports the change in cash and cash
equivalents is the statement of cash ________. WOLFS
____________40. Other comprehensive income is reported in the statement of
stockholders'. TUIQYE
Glossary
The following terms used in this module are defined as follows:
Exist whenever a person or a group of persons (principal) employs

Agency
another person or group of persons (agency), to render service (s)
Relationshi
and at the same time delegates decision making authority to the
p
agent.
Corporate is the act of creating a long-term plan to improve your business.

planning
art and science of managing money. It includes financial service and

Finance financial instruments. Finance also is referred as the provision of
money at the time when it is needed.
Financial
concerned with the efficient use of an important economic resource
manageme
namely, capital funds”.
nt
Financial The process of analyzing a company's financial statements for
Statement decision-making purposes. External stakeholders use it to
Analysis understand the overall health of an organization as well as to
evaluate financial performance and business value. Internal
constituents use it as a monitoring tool for managing the finances.
Horizontal used in financial statement analysis to compare historical data, such
analysis as ratios, or line items, over a number of accounting periods.
Long-term
An investment plan or strategy with a term of usually longer than on
Financial
e year.
Planning
This is much concerned on how to efficiently and effectively utilize the
Operational
entity’s resources to achieve the company’s short-term and long-term
planning
objectives set up during strategic planning
is a quantitative method of gaining insight into a company's liquidity,

Ratio
operational efficiency, and profitability by studying its financial
analysis
statements such as the balance sheet and income statement.
Strategic Is a process requires considerable thought and planning on the part
planning of a company’s upper-level management.
Vertical is a method of financial statement analysis in which each line item is

analysis listed as a percentage of a base figure within the statement.
References
Anastacio, F. et al. (2015). Fundamentals of Financial Management (With
Industry-Based Perspective
Cabrera, M. (2015). Financial Management Principles and Applications Volume
1
Brigham, E. & Houston, J. (2011). Financial Management Fundamentals
Paramasivan, C. & Subramanian, T. (2015). Financial Management
Module 2
Financial Assets and Time Value of Money
Module Overview:
In this module:
• Determinants of Interest Rates
• Relationship of Risk and rates of return
• Time Value of Money
Lesson 1 of this module deals with interest rates, a key determinant of asset
values. You will understand how interest rates are affected by risk, inflation, liquidity,
the supply of and demand for capital in the economy. After determining the
determinants of interest rate, in lesson 2, you will know the relations of risk and rates
of return. Understanding the relationship between risk and return will help you make
solid, informed decisions about your investments. Lesson 3 covers the time value of
money (TVM), perhaps the most fundamental concept in finance. The basic valuation
model, which ties together cash flows, risk, and interest rates, is based on TVM
concepts. Therefore, you should allocate plenty of your time to understand the concept
of Time value of Money.
• Discuss the relationship between long and short-term rates
• Identify the macroeconomic factors that influence interest rate levels.
• Understand how money grows over time using simple interest and
compound interest.
• Know the mathematical methods to determine future value and present
value of cash flows under lump sums or uneven cash flow stream.
MODULE 2, LESSON 1
Interest rates
OBJECTIVES

a. Determine the composition of market interest rates;
b. Discuss the relationship between long and short-term rates; and
c. Identify the factors that influence interest rate levels.
INTRODUCTION
Companies raise capital in two main forms: debt and equity. In a free economy,
capital, like other items, is allocated through a market system, where funds are
transferred and prices are established. The interest rate is the price that lenders
receive and borrowers pay for debt capital. Similarly, equity investors expect to receive
dividends and capital gains, the sum of which represents the cost of equity. Our focus
in this lesson is on the cost of debt. We begin by examining the factors that affect the
supply of and demand for capital, which, in turn, affects the cost of money.
Welcome to Lesson 1 of Module 2! This lesson concentrates on how market
interest rates are affected by borrowers’ need for capital, expected inflation, different
securities’ risks, and securities’ liquidity.
Activity
Task 1.
Visualize an isolated island community where people live on fish. They have a stock
of fishing gear that permits them to survive reasonably well, but they would like to have
more fish. Now suppose one of the island’s inhabitants, Mr. Crusoe, had a bright idea
for a new type of fishnet that would enable him to double his daily catch. However, it
would take him a year to perfect the design, build the net, and learn to use it efficiently.
Mr. JP would probably starve before he could put his new net into operation. Therefore,
he might suggest to Ms. Robinson, Mr. Sy and several others that if they would give
him one fish each day for a year, he would return two fish a day the next year.
1. If you are Mr. JP, would you do the same- returning two fish a day for one fish
each day for a year? What do you think factors that affects his decision?
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2. If you are Mr. Robinson or Mr. Sy, would you accept the offer or Mr. JP? What
do you think factors that affects his decision?
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3. Base on your own idea, what do you mean by return on investment?

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4. In the story, what constitutes return on investment?

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5. Base on your own idea, what do you mean by risk?

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6. In the story, what constitutes risk?

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Task 2
1. Based on the graph presented above, what is the relationship of the interest
rate on the supply and demand for funds?
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Analysis
Task 3.
Answer the following questions.
1. What role do interest rates play in allocating capital to different potential
borrowers?
Answer:
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2. How does the price of capital tend to change during a boom? during a
recession
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3. How does risk affect interest rates?

Answer:
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4. If inflation during the last 12 months was 2% and the interest rate during
that period was 5%, what was the real rate of interest? If inflation is
expected to average 4% during the next year and the real rate is 3%, what
should the current rate of interest be?
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5. If the inflation rate is expected to increase, would this increase or

decrease the slope of the yield curve? If the inflation rate is expected to
remain constant at the current level in the future, would the yield curve
slope up, slope down, or be horizontal? Consider all factors that affect the
yield curve, not just inflation.
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6. Which fluctuate more—long-term or short-term interest rates? Why?
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Abstraction
In this chapter, we discussed the way interest rates are determined, the term structure
of interest rates, and some of the ways interest rates affect business decisions. We
saw that the interest rate on a given bond, r, is based on this equation:
r=r*+ IP+ DRP + LP + MRP
Here r* is the real risk-free rate, IP is the premium for expected inflation, DRP is the
premium for potential default risk, LP is the premium for lack of liquidity, and MRP is
the premium to compensate for the risk inherent in bonds with long maturities. Both r*
and the various premiums can and do change over time depending on economic
conditions, Federal Reserve actions, and the like. Since changes in these factors are
difficult to predict, it is hard to forecast the future direction of interest rates. The yield
curve, which relates bonds’ interest rates to their maturities, usually has an upward
slope; but it can slope up or down, and both its slope and level change over time. The
main determinants of the slope of the curve are expectations for future inflation and
the MRP. We can analyze yield curve data to estimate what market participants think
future interest rates are likely to be. We will use the insights gained from this chapter
in later chapters, when we analyze the values of bonds and stocks and when we
examine various corporate investment and financing decisions.
Application
Task 4.
Direction: Show all computations in good form.
1. INFLATION AND INTEREST RATES

The real risk-free rate of interest, r*, is 3%; and it is expected to remain
constant over time. Inflation is expected to be 2% per year for the next 3 years
and 4% per year for the next 5 years. The maturity risk premium is equal to
0.1 (t – 1)%, where t = the bond’s maturity. The default risk premium for a
BBB-rated bond is 1.3%.
a. What is the average expected inflation rate over the next 4 years?
b. What is the yield on a 4-year Treasury bond?
c. What is the yield on a 4-year BBB-rated corporate bond with a liquidity
premium of 0.5%?
d. What is the yield on an 8-year Treasury bond?
e. What is the yield on an 8-year BBB-rated corporate bond with a liquidity

premium of 0.5%?
f. If the yield on a 9-year Treasury bond is 7.3%, what does that imply about
expected inflation in 9 years?
2. YIELD CURVES
The following yields on Treasury securities were taken from a recent financial
publication:
Term Rate
6 months 5.1%
1 year 5.5
2 years 5.6
3 years 5.7
4 years 5.8
5 years 6.0
10 years 6.1
20 years 6.5
30 years 6.3
a. Plot a yield curve based on these data.

b. What type of yield curve is shown?
c. What information does this graph tell you?
d. Based on this yield curve, if you needed to borrow money for longer than 1
year, would it make sense for you to borrow short-term and renew the loan or
borrow long-term? Explain.
3. REAL RISK-FREE RATE

You read in The ABC Journal that 30-day T-bills are currently yielding 5.5%.
Your brother-in-law, a broker at Safe and Sound Securities, has given you the
following estimates of current interest rate premiums:
Inflation premium= 3.25%
Liquidity premium= 0.6%
Maturity risk premium=1.8%
Default risk premium= 2.15%
On the basis of these data, what is the real risk-free rate of return?
4. EXPECTED INTEREST RATE
The real risk-free rate is 3%. Inflation is expected to be 2% this year and 4%
during the next 2 years. Assume that the maturity risk premium is zero. What
is the yield on 2-year Treasury securities?
Reflection
Task 5.
I have learned that interest rates

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I have realized that knowing real interest rate

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If I borrow money, I will apply

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Well-done! So, you have successfully completed the activities and tasks for the
lesson 1. It is expected that you have gained insights and meaningful experience in
Lesson 1. Now, you are already prepared to move to lesson 2 of this module. So?
MODULE 2, LESSON 2 Time

Value of Money
OBJECTIVES

1. understand the fundamental concepts of time value of money;
2. calculate future value and present value of a single and a series of cash
flows; and
3. apply the concepts and calculations of time value of money in personal
and corporate financial management.
4. interpret the results in computing time value amounts.
INTRODUCTION
One of the most amazing concepts about saving and investing is the time value
of money. The time value of money (TVM) is a useful tool in helping you understand
the worth of money in relation to time. It is a formula often used by investors to better
understand the value of money as it compares to its value in the future.
This lesson explores the in’s and out’s of the TVM and how they can use it to
understand the effect time has on the value of your money. You will learn to compute
for the future value of money when interest is simple; compounded; when stream of
payments is uniform and when stream of payments is unequal. You will also know how
to compute the present value of money when stream of payments is uniform or
unequal. Aside from calculation in this module, it is expected that you will be able to
have a good appreciation of the TVM (future and present) and how it impacts business
decisions.
Learning Tasks
Task 1.
3. For you, what is the meaning of the picture below? Why does time equal to
money? (Answer the question in not less than 50 words but not more than
100 words)
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Task 2.
Lucy was puzzled about something, so she went to talk to Lory about it. She told her
friend that the problem is whether she would want fifty pesos today or a 50-pesos one
year from now. She doesn't see what the difference is, since it's still fifty pesos, no
matter when you get it.
Lory had to think about this for a while. If you were Lory, what advice will you give to
Lucy?
(Answer the question in not less than 50 words but not more than 100 words)
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Task 3:
Analysis
Task 3. Answer the following question and write your answer on the space
provided. (Individual Activity)
1. Why does money have time value?
Answer:
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2. Does inflation have anything to do with making a peso today worth more
than a peso tomorrow?
Answer:
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3. If, as an investor, you had a choice of daily, monthly, or quarterly

compounding, which would you choose? Why?
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4. List 3 different financial applications of the time value of money

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Abstraction
TVM concept stands at the basis of the profitability analyses in financial management.
As the PP represents the period at the end of which the initial investment equals that
of the total cash flow generated by the investment project, we may say that this method
is connected to the notion of investment liquidity. The investment liquidity is greater as
the payback period is shorter. Discounting, as a financial technique, allows the
comparison of the revenue obtained at different moments in time with the initial costs
necessary for the implementation of an investment. This technique is useful in
determining the profitable projects. Present value remains one of the simplest and
most powerful techniques in finance, providing a wide range of applications in both
personal and business decisions. Cash flow can be moved back to present value
terms by discounting and moved forward by compounding. The discount rate at which
the discounting and compounding are done reflect three factors: (1) the preference for
current consumption, (2) expected inflation and (3) the uncertainty associated with the
cash flows being discounted”.
Application
Task 4. Direction: Answer the following question. Write your solution in your
notebook
A. It is now January 1, 2020, and you will need P 1,000 on January 1, 2024, in 4
years. Your bank compounds interest as an 8% annual rate.
5. How much must you deposit today to have a balance of P 1, 000 on
January 1, 2024?
6. If you want to make four equal payments on each January 1 from 2021 to
accumulate the P 1,000, how large must each payment be?
7. If your mother offers to make the payments calculated in #2 or to give you

P 750 on January 1, 2021 (a year from today), which would you choose?
Explain
8. If you have only P 750 on January 1, 2021, what interest rate, compounded
annually for 3 years, must you earn to have P 1,000 on January 1, 2024?
9. Suppose you can deposit only P200 on January 1 form 2021 through 2024
(4 years). What interest rate, with annual compounding, must you earn to
end up with P 1,000 on January 1, 2024?
B. Bank A offers loans at an 8% nominal rate (its APR) but requires that interest
be paid quarterly; that is, it uses quarterly compounding. Bank B wants to
charge the same effective rate on its loans but it wants to collect interest on a
monthly basis, that is, use monthly compounding. What nominal rate must Bank
B set?
Reflection
Task 5.
I have learned that the concept of Time Value of Money

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I have realized the importance of time value of money
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In my future investment, I will apply

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CONGRATULATIONS! You have just finished this module 2. Now, you are
ready to answer the post-assessment part of this module.
Post Assessment
Direction: Read each item carefully. Then, encircle the letter of the correct answer.
For questions involving problem-solving, write your solution in the given box.
1. Type of interest that accumulates the most wealth is:

a. Simple interest c. variable interest
b. Mixed interest d. compound interest
2. The amount money a person expects to have in the future is called

a. Principal c. future value
b. Interest d. present value
3. What is the future value of P 1,000 compounded annually at 8%
a. P 1,080 c. P 1, 469
b. P 1,400 d. P 1, 800
4. What is the present value of a ten-year P 1,000 ordinary annuity discounted at
6%?
a. P 4,486 c. P 7,360
b. P 6,145 d. P 10,000
5. Using a 14% annual discount rate with annual compounding, the present
value of 5 annual payments of P 4,500 each (to be received at the end of
each year) is nearest
a. P 22,500 c. P 14, 286.24
b. P 29,745.47 d. P 15,448.86
6. X Company would like to purchase a new Mercedes 450 SL that sells for P
4,300,000. It plans to take out a 4-year loan at 12% annual rate. The most
that X company can afford for monthly payments is P 100,000 but it can sell
its current car to raise additional cash for down payment. What is the
minimum amount that X company can accept for its current car and still be
able to purchase the Mercedes?
a. P 655,200 c. P 810, 300
b. P 502,600 d. P 303,700
7. Assume that B company is to make annual investment of P 300,000 for 3
years. The interest rate was pegged at 10%. The investment is made every
year end. What is the future value of this annuity?
8. Assume that B company is to make annual investment of P 300,000 for 3

years. The interest rate was pegged at 10%. The investment is made
beginning of every year. What is the future value of this annuity due?
9. The ratio or the relationship of the future value of an amount to its present
value.
a. Future value factor c. present ordinary factor
b. Present value factor d. future value factor
10. Theoretically, the present value of an ordinary annuity is the sum of all the
present values of P1.0 in a series of amounts that you will receive or pay at
the ____ of each year in the future.
a. end c. middle
b. beginning d. March
Matching: Match each word with the correct definition. Write the letter of your answer
before each number.
a. time value of money d. discounting
b. compound interest e. compounding
c. simple interest f. interest rate
____1. Exchange price between current and future value of money.

____2. Interest added to principal and paid as additional interest.
____3. Only original principal earns interest.
____4. Money is worth more at one time than at another time.
____5. Process of calculating compound interest.
____6. Compares present value of money that is received in the future.
Glossary
a financial institution that provides various products and

Bank services to its customers, including checking and savings
accounts, loans and currency exchange
Cash money in the form of paper currency or coins (as distinct from
checks, money orders or credit)
Compound Interest earning interest on interest through reinvesting. The result of
compounding
the process of leaving an initial investment plus accumulated
compounding
interest in a bank for more than one period.
decision a conclusion reached after considering alternatives and their
results.
future value
cash value of an investment at a particular time in the future
investing the process of putting money someplace with the intention of
making a financial gain
investment the amount of money invested in stocks, bonds, mutual funds
and other investment instruments
anything that is generally accepted as final payment for goods
money
and services, serves as a medium of exchange, a store of value
and a standard of value
Principal the original amount invested

simple interest interest on an investment is not reinvested, so interest is
earned each period on the original investment (principal) only
the giving up of one benefit or advantage in order to gain
trade-off
another regarded as more favorable.
References
Anastacio, F. et al. (2015). Fundamentals of Financial Management

(With Industry-Based Perspective
Cabrera, M. (2015). Financial Management Principles and Applications
Volume 1
Brigham, E. & Houston, J. (2011). Financial Management
Fundamentals
Module 3
Investing in Long-Term Assets
Module Overview:
In this module:
• Cost of Capital
• Basics of Capital Budgeting
Proper estimate of cost of capital which will be discussed in lesson 1 of this

module is important for a firm in taking capital budgeting decisions. The concept of
cost of capital plays a vital role in decision-making process of financial management.
The financial leverage, capital structure, dividend policy, working capital management,
financial decision, appraisal of financial performance of top management etc. are
greatly influenced by the cost of capital. In the last lesson of this chapter, you will learn
the capital budgeting along with its importance and example.
• Discuss the relationship between long and short-term rates
• Identify the macroeconomic factors that influence interest rate levels.
• Understand how money grows over time using simple interest and
compound interest.
• Know the mathematical methods to determine future value and present
value of cash flows under lump sums or uneven cash flow stream.
MODULE 3, LESSON 1
COST OF CAPITAL
OBJECTIVES

a. Understand the concepts of stand-alone risk, risk in a portfolio;
b. Apply statistical measures for stand-alone risk and risk in a
portfolio context to assess the trade- off between risk and return;
and
c. Discuss the difference between diversifiable risk and market risk
and explain how each type of risk affects well-diversified
investors.
INTRODUCTION
Welcome to Lesson 1 of Module 3!

In the previous lesson, the investor’s required return given a particular risk profile is
discussed. In this lesson, the question from the firm’s point of view will be examined:
How much must the firm pay to finance its operations and expansions using debt &
equity sources.
In this lesson, you will learn the importance of computing the firm’s cost of
capital and understand the specific investor-supplied capital such as debt, preferred
shares and ordinary equity. You will also learn when external equity should be availed
of and how to compute for the cost of capital using different source of financing. So
enjoy and keep reading!
Activity
Task 1.
What comes into your mind when you hear the word cost of capital?
Write your answer using a concept map.
Task 2.
Given the words you associate with the word “cost of capital”, give examples of cost
of capital. For you, what is the riskiest and highest cost of capital? The least cost of
capital?
Analysis
Task 3.
1. Identify the firm’s three major capital structure components and give their
respective component cost and weight symbols.
Answer:
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2. Why is the after-tax cost of debt rather than the before-tax cost used to
calculate the WACC?
Answer:
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3. How can the yield to maturity on a firm’s outstanding debt be used to

estimate its before-tax cost of debt?
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4. Would a firm that has many good investment opportunities be likely to

have a higher or a lower dividend payout ratio than a firm with few good
investment opportunities? Explain.
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Abstraction
Debt, Preferred Stock and Common Equity are the three major capital components.
The can be measured in different ways and one of it is the Weighted Average Cost of
Capital. Weighted Average Cost of Capital (WACC) is a weighted average of the
component costs of debt, preferred stock and common equity which is a key element
in capital budgeting. There are different factors to consider in weighing the WACC.
That’s why, firms build up a target capital structure that is used to calculate the WACC.
Before a company receives money from investors or shareholders it must first

determine if their future projected returns are large enough to pay back their investors
as well as turn a profit for the company. In order for companies to secure additional
capital they must first prove that the return on capital is greater than the cost of capital.
Application
Task 4.
How would each of the following scenarios affect a firm’s cost of debt, rd(1 –
T); its cost of equity, rs; and its WACC? Indicate with a plus (þ), a minus (–), or
a zero (0) if the factor would raise, would lower, or would have an indeterminate
effect on the item in question. Assume for each answer that other things are
held constant even though in some instances this would probably not be true.
EFFECT ON
rd (1 − T) rs WACC
a. The corporate tax rate is lowered. ________ _____ _______
b. The Federal Reserve tightens credit. ________ _____ _______
c. The firm uses more debt; that is,
it increases its debt/assets ratio. ________ _____ _______
d. The dividend payout ratio is increased. ________ ______ _______
e. The firm doubles the amount of capital
it raises during the year. ________ ______ _______
f. The firm expands into a risky new area. ________ ______ _______
2. Rainier Corporation is planning to sell a new 12% bond maturing in 1.5 years at
P 1,000 each. Each bond has a floatation charge of P 30. If the firm’s marginal tax
rate is 34%, what is the approximate after-tax cost of new bonds?
3. Martin Enterprises has compiled the following information about its capital
structure and estimated costs of new financing:
Source of capital Book Value Market Value After-Tax

Cost (%)
Long-term debt P 2,000,000 P 1,800,000 7
Preferred stock 500,000 600,000 12
Ordinary equity 1,500,000 3,600,000 16
Total P 4,000,000 P 6,000,000
The company expects to have s significant amount of retained earnings available

and does not expect to sell any additional ordinary equity.
What is the firm’s WACC, using book value? Using market value?
Reflection
Task 5.
(Individual Activity, but you can share it with your peers)
I have learned that cost of capital
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I have realized that the importance of cost of capital
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I will apply in my future business the concept of cost of capital by
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MODULE 3, LESSON 2
CAPITAL BUDGETING
OBJECTIVES

1. Understand the importance of capital budgeting;
2. Apply the commonly used capital budgeting techniques under the
Discounted Cash Flow approach as well as the Non-discounted Cash Flow
approach; and
3. Recommend whether to “accept or reject” a particular investment proposal
or proposed “select” from among alternative investment projects.
INTRODUCTION

In the previous lesson, we discussed the cost of capital. Now we turn to
investment decisions involving fixed assets, or capital budgeting. Here capital refers
to long-term assets used in production, while a budget is a plan that outlines projected
expenditures during some future period. Thus, the capital budget is a summary of
planned investments in long-term assets, and capital budgeting is the whole process
of analyzing projects and deciding which ones to include in the capital budget.
In this lesson, you will understand what capital budgeting is. You will also
calculate and use the major capital budgeting decision criteria to make a sound-
business decision.
Activity
Task 1.
Complete the statements below.
1. In finance, the word capital refers to

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Budgeting means
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2. So, capital budgeting is

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3. Capital expenditure means

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4. The examples of capital expenditure are ___________________________,
_____________________________ and ________________________.
Analysis
Task 2.
1. Why do we focus on cash flows as opposed to net income in capital
budgeting?
Answer:
___________________________________________________________________
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___________________________________________________________________
___________________________________________________________________
___________________________________________________________________
___________________________________________________________________
___________________________________________________________________
___________________________________________.
2. Explain why sunk costs should not be included in a capital budgeting

analysis, but opportunity costs and externalities should be included.
Give an example of each.
Answer:
_________________________________________________________
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________________________________________________________.
3. If a project with conventional cash flows has a payback period less

than the project’s life, can you definitively state the algebraic sign of the
NPV? Why or Why not? If you know that the discounted payback period
is less than project’s life, what can you say about the NPV? Explain
Answer:
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________________________________________________________.
4. Suppose a project has conventional cash flows and positive NPV.

What do you know about its payback? Its discounted payback? Its
profitability index? Its IRR? Explain.
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_________________________________________________________
_________________________________________________________
_________________________________________________________
_________________________________________________________
_________________________________________________________
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________________________________________________________.
Abstraction
Capital budgeting is the whole process of analyzing projects and deciding which ones
to include in the capital budget. Capital budget is a summary of planned investments
in long-term assets since capital refers to long-term used assets used in production,
while budget means a plan that outlines projected expenditures during some future
period.
Five techniques used to evaluate proposed capital budgeting projects are: (1) NPV,
which is the best single measure that tells us how much value each project contributes
to shareholder wealth, (2) IRR, a method that is widely used but its recent growth is
less dramatic than the NPV, (3) MIRR, which with IRR measure profitability expressed
as percentage rate of return, which is interesting to decision makers, (4) Payback, an
easier way to calculate and provide information about the firm’s performance, (5)
Discounted payback, which provides indicator of a project’s liquidity and risk.
Different measures provide different types of information. All of them should be

considered in making capital budgeting decisions since all of them are easy to
calculate. However, NPV should be given the greatest weight since it is the best
among the five criteria.
Application
Task 4.
1. Thelma Industries is considering an expansion. The necessary equipment

would be purchased for P 9 million, and the expansion would require and
additional P 3 million investment in net operating working capital. The tax rate
is 40%.
a. What is the initial investment outlay?
b. The company spent and expensed P 50,000 on research related to the

project last year. Would this change your answer? Explain.
c. The company plans to use a building that it owns to house project. The
building could be sold for 1 million after taxes and real estate
commissions. How would that affect your answer?
2. What is the payback period for the following set of cash flows?
Year Cash Flow
0 -P 6,400
1 1,600
2 1,900
3 2,300
4 1,400
3. A firm evaluates all of is projects by applying the IRR rule. If the required
return is 16%, should the firm accept the following project?
Year Cash Flow
0 -P 34,000
1 16,000
2 18,000
3 15,000
4. What is the probability index for the following set of cash flows if the relevant
discount rate is 10%? What if the discount rate is 15%? If it is 22%?
Year Cash Flow
0 -P 14,000
1 7,300
2 6,900
3 5,700
Reflection
Task 5.
I have learned that capital budgeting
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I have realized that the importance of capital budgeting
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I will apply the methods of capital budgeting

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CONGRATULATIONS! You have just finished this module. You can now
answer the post-assessment of this module. Good Luck!
Post Assessment
1. Which of the following statements is TRUE?
a. The payback method of project evaluation considers all the relevant cash
flows from a project but neglects the consideration of risk and time-value
of money
b. The payback period of a project is a measure of the project’s liquidity.
c. The average rate of return (ARR) method of project evaluation considers
all the relevant cash flows from a project but neglects the consideration of
risk and time value of money.
d. Using a discount rate of 12%, the present value of a project’s expected
future cash flows is P 1,000. The net investment cash outlay is P 1,100.
The IRR of this project is greater than 12%.
2. Which of the following statements is FALSE?
a. The IRR is the discount rate that equates the present value of a project’s
expected cash inflows with its net present value.
b. The IRR is the discount rate that makes the net present value of a project
equal to zero.
c. The IRR is the maximum discount rate that will give a non-negative net
present value.
d. Consider an investment opportunity that costs P 10,000 and promises to
pay a single lump sum of P 13,000 three years from now. In this situation,
invested capital will increase over the life of the investment.
3. Which of the following statements is TRUE?

a. Consider an investment opportunity that costs P 10,000 and promises to
pay a single lump sum of P 13,000 three years from now. The IRR of this
investment is 10%.
b. Consider an investment opportunity that costs P 1,500 and promises to
pay P 150 at the end of each year for four years. Along with the final 150
annual payment, the investment will also repay the P 1,500 principal. The
IRR of this investment is 10%.
c. Consider an investment opportunity that costs P 1,500 and promises to
pay P 150 at the end of each year for twenty years. The IRR of this
investment is 10%.
d. You are the financial manager for a small private college. A local business
has proposed giving the school a mainframe computer, free of charge. If
you accept the gift, your school will save P 200,000 per year in charges for
off-campus computer services. You expect to use the computer for 10
years and then donate it to some worthy cause. The IRR of this project is
zero.
Questions 4 & 5 pertains to the following information:
Gregory, Inc. manufactures mattress. The financial manager is considering a project
proposal involving an expansion of productive capacity through the purchase of new
manufacturing equipment. The purchase price of the equipment is P 750,000.
Assume that the equipment will be depreciated for tax purposes over three years at
P 250,000 per year. The project is expected to last for 3 years. At the end of this
time, the project will be terminated. The equipment is expected to be worthless at
that time. The project is expected to increase annual cash revenue by P 450,000 and
increase cash operating expenses by P 150,000. Use a 34% marginal tax rate for
your calculations.
4. Using the information given above, the payback period for this project is
a. Less than 1 year
b. Between 1 year and 2 years
c. Between 2 years and 3 years
d. More than 3 years.
5. Using information given above, the average rate of return for this project is
nearest
a. 13.2%
b. 4.4%
c. 39.6%
d. 8.8%
6. Campbell Co. is trying to estimate its weighted average cost of capital

(WACC). Which of the following statements is most correct?
a. The after-tax cost of debt is generally cheaper than the after-tax cost of equity.
b. Since retained earnings are readily available, the cost of retained earnings is
generally lower than the cost of debt.
c. The after-tax cost of debt is generally more expensive than the before-tax cost
of debt.
d. Statements a and c are correct.
7-10 Billick Brothers is estimating its WACC. The company has collected the
following information:
Its capital structure consists of 40 percent debt and 60 percent common equity.
The company has 20-year bonds outstanding with a 9 percent annual coupon that
are trading at par.
The company’s tax rate is 40 percent.
The risk-free rate is 5.5 percent.
The market risk premium is 5 percent.
The stock’s beta is 1.4.
What is the company’s WACC?
a. 9.71%
b. 9.66%
c. 8.31%
d. 11.18%
Direction: Write T if the statement is true and F if the statement is false.
_____11. Capital can be defined as the funds supplied by investor.

_____12. The before-tax cost of debt, which is lower than the after-tax cost, is
used as the component cost of debt for purposes of developing the
firm's WACC.
_____13. The cost of common stock is the rate of return stockholders require on
the firm's common stock
____14. The lower the firm's tax rate, the lower will be the firm's after-tax
cost of debt and WACC, other things held constant.
____15. Suppose the debt ratio (D/TA) is 10 percent, the current cost of debt
is 8 percent, the current cost of equity is 16 percent, and the tax rate is 40 percent.
An increase in the debt ratio to 20 percent would decrease the weighted average
cost of capital.
References

1
Glossary
Or simple rate of return is measure of a project’s profitability

Accounting Rate of return from a conventional accounting standpoint by relating the
required investment to the future annual net income.
Capital Component One of the types of capital used by firms to raise funds.
Is a capital budgeting method that determines the length of

Discounted Payback
time required for an investments cash flows, discounted at
Period
the investments cost of capital, to cover its cost.
Flotation Cost, F The percentage cost of issuing new common stock.
Also known as discounted rate and time-adjusted rate of

return is the rate which equates the present value of the
IRR
future cash inflows with the cost of the investment which
produces them
Net Investment Is the net initial cash outlay needed to acquire a specific
investment project.
Are the incremental changes in a firm’s cash flows that

Net operating cash flows
result from investing in a project.
Is the excess of the present values of a project’s cash
Net Present Value inflows (net operating cash flows plus net terminal cash)
Is the length of time required for a project’s cumulative net

Payback period
cash inflows to equal its net investment.
Measures the rate of recovery of investment during the
Payback reciprocal
payback period.
Also known as benefit/cost ratio present value desirability
Profitability Index index, is the ratio of the total present value of future cash
inflows divided by its net investment.
Weighted Average Cost of A weighted average of the component costs of debt,
Capital (WACC) preferred stock, and common equity.
References

1
Module 4
Working Capital Management
Module Overview:
In this module:
o Working Capital
o Working Capital Management
Working capital management is also one of the important parts of the financial
management. It is concerned with short-term finance of the business concern which
is a closely related trade between profitability and liquidity. Efficient working capital
management leads to improve the operating performance of the business concern and
it helps to meet the short-term liquidity. Hence, study of working capital management
is not only an important part of financial management but also are overall management
of the business concern.
• Define working capital and working capital management

• Understand the concept and needs of working capital
• Identify the types and sources of working capital
• Calculate working capital
• Understand Working capital Management
MODULE 4, LESSON 1
WORKING CAPITAL
OBJECTIVES

a. Understand working capital and its concept, types, sources and needs;
b. Calculate working capital; and
c. Discuss the factors determining working capital.
INTRODUCTION

In this lesson you will understand working capital, its uses and importance. You
will also learn the importance of managing working capital. Enjoy and keep learning!
Activity
Task 1.
What comes into your mind when you hear the word working capital?
Task 1
Thought-bubble Activity!
Write your own thoughts about the meaning of the word “working capital”. Include
examples, characteristics and the type of investment you know. Your answer must not
less than 50 words.
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Analysis
Task 2.
1. Discuss the concept of working capital?
Answer:
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2. What are the types of working capital?
Answer:
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3. Explain the needs of working capital.
Answer:
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4. Critically explain the factors affecting the requirement of working capital.
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Abstraction
MEANING OF WORKING CAPITAL
Capital of the concern may be divided into two
1. Fixed capital means that capital, which is used for long-term investment of the
business concern. For example, purchase of permanent assets. Normally it
consists of non-recurring in nature.
2. Working Capital is another part of the capital which is needed for meeting day
to day requirement of the business concern. For example, payment to creditors,
salary paid to workers, purchase of raw materials etc., normally it consists of
recurring in nature. It can be easily converted into cash. Hence, it is also known
as short-term capital.
Definitions
According to the definition of Mead, Baker and Malott, “Working Capital means Current
Assets”.
According to the definition of J.S.Mill, “The sum of the current asset is the working
capital of a business”. According to the definition of Weston and Brigham, “Working
Capital refers to a firm’s investment in short-term assets, cash, short-term securities,
accounts receivables and inventories”.
According to the definition of Bonneville, “Any acquisition of funds which increases the
current assets, increase working capital also for they are one and the same”.
According to the definition of Shubin, “Working Capital is the amount of funds

necessary to cover the cost of operating the enterprises”.
According to the definition of Genestenberg, “Circulating capital means current assets

of a company that are changed in the ordinary course of business from one form to
another, for example, from cash to inventories, inventories to receivables, receivables
to cash”.
CONCEPT OF WORKING CAPITAL
Working capital can be classified or understood with the help of the following two
important concepts.
Gross Working Capital Gross Working Capital is the general concept which
determines the working capital concept. Thus, the gross working capital is the capital
invested in total current assets of the business concern.
Gross Working Capital is simply called as the total current assets of the concern.
GWC = CA
Net Working Capital Net Working Capital is the specific concept, which, considers both
current assets and current liability of the concern.
Net Working Capital is the excess of current assets over the current liability of the
concern during a particular period. If the current assets exceed the current liabilities it
is said to be positive working capital; it is reverse, it is said to be Negative working
capital.
NWC = C A – CL
Component of Working Capital

Current Assets Current Liability
Cash on Hand Bills Payable
Cash in Bank Accounts Payable
Accounts Receivable Short-term Loans and advances
Accrued Income
Inventories
Prepaid Expenses
TYPES OF WORKING CAPITAL

Working Capital may be classified into three important types on the basis of time.
1. Permanent Working Capital It is also known as Fixed Working Capital. It is the
capital; the business concern must maintain certain amount of capital at
minimum level at all times. The level of Permanent Capital depends upon the
nature of the business. Permanent or Fixed Working Capital will not change
irrespective of time or volume of sales.
2. Temporary Working Capital It is also known as variable working capital. It is the
amount of capital which is required to meet the Seasonal demands and some
special purposes. It can be further classified into Seasonal Working Capital and
Special Working Capital. The capital required to meet the seasonal needs of
the business concern is called as Seasonal Working Capital. The capital
required to meet the special exigencies such as launching of extensive
marketing campaigns for conducting research, etc.
3. Semi Variable Working Capital Certain amount of Working Capital is in the field
level up to a certain stage and after that it will increase depending upon the
change of sales or time.
NEEDS OF WORKING CAPITAL
Working Capital is an essential part of the business concern. Every business concern
must maintain certain amount of Working Capital for their day-to-day requirements and
meet the short-term obligations.
Working Capital is needed for the following purposes.
1. Purchase of raw materials and spares: The basic part of manufacturing process is,
raw materials. It should purchase frequently according to the needs of the business
concern. Hence, every business concern maintains certain amount as Working Capital
to purchase raw materials, components, spares, etc.
2. Payment of wages and salary: The next part of Working Capital is payment of wages
and salaries to labor and employees. Periodical payment facilities make employees
perfect in their work. So, a business concern maintains adequate the amount of
working capital to make the payment of wages and salaries.
3. Day-to-day expenses: A business concern has to meet various expenditures

regarding the operations at daily basis like fuel, power, office expenses, etc.
4. Provide credit obligations: A business concern responsible to provide credit facilities
to the customer and meet the short-term obligation. So, the concern must provide
adequate Working Capital.
Working Capital Position/ Balanced Working Capital Position.

A business concern must maintain a sound Working Capital position to improve the
efficiency of business operation and efficient management of finance. Both excessive
and inadequate Working Capital lead to some problems in the business concern.
A. Causes and effects of excessive working capital.
(i) Excessive Working Capital leads to unnecessary accumulation of raw
materials, components and spares.
(ii) Excessive Working Capital results in locking up of excess Working Capital.
(iii) It creates bad debts, reduces collection periods, etc.
(iv) It leads to reduce the profits.
B. Causes and effects of inadequate working capital
(i) Inadequate working capital cannot buy its requirements in bulk order.
(ii) It becomes difficult to implement operating plans and activate the firm’s
profit target.
(iii) It becomes impossible to utilize efficiently the fixed assets.
(iv) The rate of return on investments also falls with the shortage of Working
Capital.
(v) It reduces the overall operation of the business.
FACTORS DETERMINING WORKING CAPITAL REQUIREMENTS

Working Capital requirements depends upon various factors. There are no set of rules
or formula to determine the Working Capital needs of the business concern. The
following are the major factors which are determining the Working Capital
requirements.
1. Nature of business: Working Capital of the business concerns largely depend
upon the nature of the business. If the business concerns follow rigid credit
policy and sell goods only for cash, they can maintain lesser amount of Working
Capital. A transport company maintains lesser amount of Working Capital while
a construction company maintains larger amount of Working Capital.
2. Production cycle: Amount of Working Capital depends upon the length of the
production cycle. If the production cycle length is small, they need to maintain
lesser amount of Working Capital. If it is not, they have to maintain large amount
of Working Capital.
3. Business cycle: Business fluctuations lead to cyclical and seasonal changes in

the business condition and it will affect the requirements of the Working Capital.
In the booming conditions, the Working Capital requirement is larger and in the
depression condition, requirement of Working Capital will reduce. Better
business results lead to increase the Working Capital requirements.
4. Production policy: It is also one of the factors which affects the Working Capital
requirement of the business concern. If the company maintains the continues
production policy, there is a need of regular Working Capital. If the production
policy of the company depends upon the situation or conditions, Working
Capital requirement will depend upon the conditions laid down by the company.
5. Credit policy: Credit policy of sales and purchase also affect the Working
Capital requirements of the business concern. If the company maintains liberal
credit policy to collect the payments from its customers, they have to maintain
more Working Capital. If the company pays the dues on the last date it will
create the cash maintenance in hand and bank.
6. Growth and expansion: During the growth and expansion of the business
concern, Working Capital requirements are higher, because it needs some
additional Working Capital and incurs some extra expenses at the initial stages.
7. Availability of raw materials: Major part of the Working Capital requirements are
largely depend on the availability of raw materials. Raw materials are the basic
components of the production process. If the raw material is not readily
available, it leads to production stoppage. So, the concern must maintain
adequate raw material; for that purpose, they have to spend some amount of
Working Capital.
8. Earning capacity: If the business concern consists of high level of earning
capacity, they can generate more Working Capital, with the help of cash from
operation. Earning capacity is also one of the factors which determines the
Working Capital requirements of the business concern.
COMPUTATION (OR ESTIMATION) OF WORKING CAPITAL

Working Capital requirement depends upon number of factors, which are already
discussed in the previous parts. Now the discussion is on how to calculate the Working
Capital needs of the business concern. It may also depend upon various factors but
some of the common methods are used to estimate the Working Capital.
A. Estimation of components of working capital method Working capital consists of
various current assets and current liabilities. Hence, we have to estimate how much
current assets as inventories required and how much cash required to meet the short-
term obligations. Finance Manager first estimates the assets and required Working
Capital for a particular period.
B. Percent of sales method Based on the past experience between Sales and Working
Capital requirements, a ratio can be determined for estimating the Working Capital
requirement in future. It is the simple and tradition method to estimate the Working
Capital requirements. Under this method, first we have to find out the sales to Working
Capital ratio and based on that we have to estimate Working Capital requirements.
This method also expresses the relationship between the Sales and Working Capital.
C. Operating cycle Working Capital requirements depend upon the operating cycle of
the business. The operating cycle begins with the acquisition of raw material and ends
with the collection of receivables.
Operating cycle consists of the following important stages:
1. Raw Material and Storage Stage, (R)
2. Work in Process Stage, (W)
3. Finished Goods Stage, (F)
4. Debtors Collection Stage, (D)
5. Creditors Payment Period Stage. (C)
Each component of the operating cycle can be calculated by the following formula:
Average Stock of Raw Material

R=
Average Raw Material Consumption Per day
Average Work in Process Inventory

W=
Average Cost of Production Per day
Average Finished Stock Inventory

F=
Average Cost of Goods Sold Per day
Average Book debts

D=
Average Credit Sales Per day
Average Trade Creditors

C=
Average Credit Purchase Per day
Application
Task 3.
How would each of the following scenarios affect a firm’s cost of debt, rd(1 –
T); its cost of equity, rs; and its WACC? Indicate with a plus (þ), a minus (–), or
a zero (0) if the factor would raise, would lower, or would have an indeterminate
effect on the item in question. Assume for each answer that other things are
held constant even though in some instances this would probably not be true.
EFFECT ON
rd (1 − T) rs WACC
a. The corporate tax rate is lowered. ________ _____ _______
b. The Federal Reserve tightens credit. ________ _____ _______
c. The firm uses more debt; that is,
it increases its debt/assets ratio. ________ _____ _______
d. The dividend payout ratio is increased. ________ ______ _______
e. The firm doubles the amount of capital
it raises during the year. ________ ______ _______
f. The firm expands into a risky new area. ________ ______ _______
2. Rainier Corporation is planning to sell a new 12% bond maturing in 1.5 years at P
1,000 each. Each bond has a floatation charge of P 30. If the firm’s marginal tax rate
is 34%, what is the approximate after-tax cost of new bonds?
3. Martin Enterprises has compiled the following information about its capital
structure and estimated costs of new financing:
Source of capital Book Value Market Value After-Tax Cost

(%)
Long-term debt P 2,000,000 P 1,800,000 7
Preferred stock 500,000 600,000 12
Ordinary equity 1,500,000 3,600,000 16
Total P 4,000,000 P 6,000,000
The company expects to have s significant amount of retained earnings available

and does not expect to sell any additional ordinary equity.
What is the firm’s WACC, using book value? Using market value?
Reflection
Task 4.
I have learned that working capital
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I have realized that the management of working capital
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I will apply my working capital learnings
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MODULE 4, LESSON 2
WORKING CAPITAL
MANAGEMENT
OBJECTIVES

1. Understand the concept of working capital management.
2. Know the importance of working capital management.
3. Identify and understand the factors affecting the firm’s working capital
policy.
4. Understand and calculate the operating cycle and cash conversion cycle
of a business firm.
INTRODUCTION

The term working capital originated with the old Yankee peddler who would load
up his wagon and go off to peddle his wares. The merchandise was called “working
capital” because it was what he actually sold, or “turned over,” to produce his profits.
The wagon and horse were his fixed assets. He generally owned the horse and wagon
(so they were financed with “equity” capital), but he bought his merchandise on credit
(that is, by borrowing from his supplier) or with money borrowed from a bank. Those
loans were called working capital loans, and they had to be repaid after each trip to
demonstrate that the peddler was solvent and worthy of a new loan. Banks that
followed this procedure were said to be employing “sound banking practices.” The
more trips the peddler took per year, the faster his working capital turned over and the
greater his profits.
This concept can be applied to modern businesses, as we demonstrate in this

lesson. We begin with a review of two basic definitions that were covered in the
previous lesson.
Activity
Task 1.
In your own thoughts, what do you think is the importance of working capital
management?
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Analysis
Task 2.
1. Identify and explain three alternative current asset investment policies.
Answer:
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2. Use the DuPont equation to show how working capital policy affects a
firm’s expected ROE.
Answer:
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3. Differentiate between permanent current assets and temporary current
assets.
Answer:
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4. How would a reduction in the cash conversion cycle increase profitability?
Answer:
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5. Suppose a firm’s cash flows do not occur uniformly throughout the

month. What effect would this have on the accuracy of the forecasted
borrowing requirements based on a monthly cash budget? How could the
firm deal with this problem?
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4. How has the development of credit and debit cards affected firms’
currency holdings?
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5. How does collection policy influence sales, the collection period, and the bad
debt loss percentage?
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Abstraction
Working capital. Current assets are often called working capital because these assets
“turn over” (i.e., are used and then replaced all during the year).
Net working capital. When a firm buys inventory on credit, its suppliers in effect lend it
the money used to finance the inventory. The firm could have borrowed from its bank
or sold stock to obtain the money, but it received the funds from its suppliers. These
loans are recorded as accounts payable, and they are typically “free” in the sense that
they do not bear interest. Similarly, Allied pays its workers every 2 weeks and pays
taxes quarterly, so its labor force and the tax authorities provide it with loans equal to
its accrued wages and taxes. If we subtract the sum of payables plus accruals from
current assets, the difference is called net working capital, which represents the
amount of money that the firm must obtain from non-free sources to carry its current
assets.
Net working capital=Current assets – (Payables + Accruals)
Current Asset Financing Policies

Investments in current assets must be financed; and the primary sources of funds
include bank loans, credit from suppliers (accounts payable), accrued liabilities, long-
term debt, and common equity. Each of those sources has advantages and
disadvantages, so each firm must decide which sources are best for it.
Maturity Matching, or “Self-Liquidating,” Approach
The maturity matching, or "self-liquidating," approach calls for matching asset and
liability maturities as shown in Panel a of Figure 16-2. This strategy minimizes the risk
that the firm will be unable to pay off its maturing obligations. To illustrate, suppose a
company borrows on a one-year basis and uses the funds obtained to build and equip
a plant. Cash flows from the plant (profits plus depreciation) would not be sufficient to
pay off the loan at the end of only one year, so the loan would have to be renewed. If
for some reason the lender refused to renew the loan, then the company would have
problems. Had the plant been financed with long-term debt, however, the required loan
payments would have been better matched with cash flows from profits and
depreciation, and the problem of renewal would not have arisen.
At the limit, a firm could attempt to match exactly the maturity structure of its assets
and liabilities. Inventory expected to be sold in 30 days could be financed with a 30-
day bank loan; a machine expected to last for 5 years could be financed with a 5-year
loan; a 20-year building could be financed with a 20-year mortgage bond; and so forth.
In practice, firms don't actually finance each specific asset with a type of capital that
has a maturity equal to the asset's life. However, academic studies do show that most
firms tend to finance short-term assets from short-term sources and long-term assets
from long-term sources.
Aggressive Approach
The aggressive approach is a high-risk strategy of working capital financing wherein
short-term finances are utilized not only to finance the temporary working capital but
also a reasonable part of the permanent working capital. In this approach of financing,
the levels of inventory, accounts receivables and bank balances are just sufficient with
no cushion for uncertainty. There is a reasonable dependence on the trade credit.
Fixed assets and a part of permanent working capital are financed by long-term
financing sources and the remaining part of permanent working capital and total
temporary working capital is only is financed by short-term financing sources.
Application
Task 3.
Direction: Answer the following questions. For question involving solving problem,
show all computations in good form.
1. Indicate using a (+), (-), or (0) whether each of the following events would
probably cause accounts receivable (A/R), sales, and profits to increase,
decrease, or be affected in an indeterminate manner:
AR Sales Profit
1. The firm tightens its credit standards. ____ ____ ____
2. The terms of trade are changed
from 2/10, net 30, to 3/10, net 30. ____ _____ ____
3. The terms are changed from 2/10,
net 30, to 3/10, net 40. _____ _____ _____
4. The credit manager gets tough
with past due accounts. _____ _____ _____
2. CASH CONVERSION CYCLE

Primrose Corp has P15 million of sales, P2 million of inventories, P3 million of
receivables, and P1 million of payables. Its cost of goods sold is 80% of sales,
and it finances working capital with bank loans at an 8% rate. What is
Primrose’s cash conversion cycle (CCC)? If Primrose could lower its inventories
and receivables by 10% each and increase its payables by 10%, all without
affecting sales or cost of goods sold, what would be the new CCC, how much
cash would be freed up, and how would that affect pretax profits?

3. RECEIVABLES INVESTMENT
Lamar Lumber Company has sales of P10 million per year, all on credit terms
calling for payment within 30 days; and its accounts receivable are P2 million.
What is Lamar’s DSO, what would it be if all customers paid on time, and how
much capital would be released if Lamar could take action that led to on-time
payments?

4. COST OF TRADE CREDIT AND BANK LOAN Lamar Lumber buys P8 million
of materials (net of discounts) on terms of 3/5, net 60; and it currently pays after
5 days and takes discounts. Lamar plans to expand, which will require
additional financing. If Lamar decides to forgo discounts, how much additional
credit could it get and what would be the nominal and effective cost of that
credit? If the company could get the funds from a bank at a rate of 10%, interest
paid monthly, based on a 365-day year, what would be the effective cost of the
bank loan? Should Lamar use bank debt or additional trade credit? Explain.
5. WORKING CAPITAL POLICY

Rentz Corporation is investigating the optimal level of current assets for the coming
year. Management expects sales to increase to approximately P2 million as a
result of an asset expansion presently being undertaken. Fixed assets total P1
million, and the firm plans to maintain a 60% debt ratio. Rentz’s interest rate is
currently 8% on both short-term and longer-term debt (which the firm uses in its
permanent structure). Three alternatives regarding the projected current assets
level are under consideration: (1) a tight policy where current assets would be only
45% of projected sales, (2) a moderate policy where current assets would be 50%
of sales, and (3) a relaxed policy where current assets would be 60%ofsales.
Earnings before interest and taxes should be12%oftotalsales, and the federal-plus-
state tax rate is 40%.
a. What is the expected return on equity under each current asset level?
b. In this problem, we assume that expected sales are independent of the current
asset policy. Is this a valid assumption? Why or why not?
c. How would the firm’s risk be affected by the different policies?


Reflection
Task 4.
I have learned that working capital management

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I have realized that without effective working capital management
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I will apply my learnings in working capital management
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CONGRATULATIONS! You have just finished this module. You can now
answer the post-assessment of this module. Good Luck!
Post Assessment
1. The following are to be reported as cash and cash equivalent except:

a. The cash that is available for use and unrestricted.
b. The cash in a closed bank.
c. The cash used to replenish the petty cash fund
d. The cash to pay today’s purchases.
2. Inventories encompass all of the following except:

a. Merchandise purchased by a retailer
b. Land and other property not held for sale
c. Finished goods produced.
d. Materials and supplies awaiting use in the production process.
3. Assuming that JCP Corporation places its inventory at SM Makati on

consignment, the cost of inventory place at SM at the end of the accounting
period should be included in the inventory of:
a. The consignor but not on the consignee
b. Books of the consignor and the consignee
c. The consignee but not on the consignor.
d. Neither the consignor nor the consignee.

4. Which of the following would be consistent with a more aggressive approach

to financing working capital?
a. Financing short-term needs with short-term funds.
b. Financing permanent inventory buildup with long-term debt.
c. Financing seasonal needs with short-term funds.
d. Financing some long-term needs with short-term funds.
5. Which of the following illustrates the use of a hedging (or matching) approach
to financing?
a. Short-term assets financed with long-term liabilities.
b. Permanent working capital financed with long-term liabilities.
c. Short-term assets financed with equity.
d. All assets financed with a 50 percent equity, 50 percent long-term debt
mixture.
6. Permanent working capital
a. varies with seasonal needs.
b. includes fixed assets.
c. is the amount of current assets required to meet a firm's long-term
minimum needs.
d. includes accounts payable.
7. Which asset-liability combination would most likely result in the firm's having
the greatest risk of technical insolvency?
a. Increasing current assets while lowering current liabilities.
b. Increasing current assets while incurring more current liabilities.
c. Reducing current assets, increasing current liabilities, and reducing long-
term debt.
d. Replacing short-term debt with equity.
8. Below are the elements of credit policy except:
a. Cash discount c. Credit period
b. Trade discount d. Credit standard
9. Net Woking capital refers to
a. Total current Assets c. Current Asset + Current Liabilities
b. Current Assets - Current Liabilities d. Current Liabilities - Current Assets
10. The cash conversion cycle equals:
a. inventory period + collection period - payables period
b. payables period - inventory period - collection period
c. payables period + inventory period - collection period
d. inventory period - collection period + payables period
Instructions: Write True if the statement is true and False if the statement is false.
11. Working capital is net of assets and liabilities.

12. The formula for computing current ratio is current assets divided by current
liabilities.
13. Receivable is an example of quick asset.
14. The quick ratio is a better analytical tool as compared to current ratio in
determining the company’s paying capabilities of its long-term loans payable
with the bank.
15. Accounts payable is a component for computing current and quick ratio.

16. An accountant should manage well the current ratio for smooth business
operation.
17. Positive working capital shows that firm may not able to meet it current
liabilities.
18. Restricted Current Asset Investment policy means relatively large amounts of
cash, marketable securities, and inventories are carried; and a liberal credit
policy results in a high level of receivables.
19. Credit standards is the length of time buyers are given to pay for their
purchases.
20. Add-on Interest means interest that is calculated and added to funds received
to determine the face amount of an installment loan.
References

1

Glossary
Account Receivable Funds due from a customer.
Continually recurring short-term liabilities, especially accrued
Accruals wages and accrued taxes.
Interest that is calculated and added to funds received to
Add-On Interest determine the face amount of an installment loan.
The average length of time required to convert the firm’s

Average Collection Period (ACP) receivables into cash, that is, to collect cash following a sale.
The length of time funds are tied up in working capital or the
length of time between paying for working capital and
collecting cash from the sale of the working capital.
Cash Conversion Cycle (CCC)
The degree of toughness in enforcing the credit terms.
Collection Policy
Unsecured, short-term promissory notes of large firms,
usually issued in denominations of P100,000 or more with an
interest rate somewhat below the prime rate.
Commercial Paper
Credit taken in excess of free trade credit, whose cost is
Costly Trade Credit equal to the discount lost.
The length of time customers have to pay for purchases.
Credit Period
A set of rules that includes the firm’s credit period, discounts,

credit standards, and collection procedures offered.
Credit Policy
A numerical score from 0 to 10 that indicates the likelihood
Credit Score that a person or business will pay on time.
The financial strength customers must exhibit to qualify for
credit.
Credit Standards
Statement of the credit period and any discount offered.
Credit Terms
Current Assets Financing Policy The way current assets are financed
Discounts
Price reductions given for early payment.
Credit received during the discount period.
Free Trade Credit
The average time required to convert raw materials into
finished goods and then to sell them.
Inventory Conversion Period
An arrangement in which a bank agrees to lend up to a
specified maximum amount of funds during a designated
period.
Line of Credit
A post office box operated by a bank to which payments are
Lockbox sent. Used to speed up effective receipt of cash

Maturity Matching, or “Self-Liquidating,” Approach A financing policy that matches asset and liability maturities.
This is a moderate policy.
Moderate Current Asset Investment Policy
Between the relaxed and restricted policies.
The average length of time between the purchase of
materials and labor and the payment of cash for them.
Payables Deferral Period
A document specifying the terms and conditions of a loan,

Promissory Note including the amount, interest rate, and repayment schedule.
Current assets that a firm must carry even at the trough of its
Permanent Current Assets cycles.
A published interest rate charged by commercial banks to
Prime Rate large, strong borrowers.
Regular, or Simple, Interest
The situation when only interest is paid monthly.
Relatively large amounts of cash, marketable securities, and
inventories are carried; and a liberal credit policy results in a
Relaxed Current Asset Investment Policy high level of receivables.
Restricted Current Asset Investment Policy Holdings of cash, marketable securities, inventories, and
receivables are constrained.
A formal, committed line of credit extended by a bank or
Revolving Credit Agreement another lending institution.
A loan backed by collateral, often inventories or accounts
receivable.
Secured Loan
The desired cash balance that a firm plans to maintain in
Target Cash Balance order to conduct business.
Temporary Current Assets Current assets that fluctuate with seasonal or cyclical
variations in sales.
Debt arising from credit sales and recorded as an account
receivable by the seller and as an account payable by the
buyer.
Trade Credit

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KAPALONG COLLEGE OF AGRICULTURE, SCIENCES AND TECHNOLOGY

1ST SEMESTER 2020-2021 ESTRELLIETA R. OLAER

Finance is the lifeblood of business organization. It is difficult for organizations,

Module 1: Fundamental Concepts in Financial Management and Financial

Module 3: Investing in Long-Term Assets: Capital Budgeting

• Apply concepts and techniques in finance in evaluating financial

Careful consideration was given to the sequencing of the lessons, hence,

Module 1: Fundamental Concepts in Financial Management and Financial Forecasting

Are you ready? Then start the lessons now!

At the end of the module, the students should be able to:

a. explain the definition and evolution of finance as a recognized field of study;

Time Frame This lesson is expected to be finished in 1 week