ReSA - THE REVIEW SCHOOL OF ACCOUNTANCY

CPA Review Batch 45  May 2023 CPA Licensure Examination

MS-10
MANAGEMENT SERVICES Aljon Lee  Elirie Arañas  Kenneth Manuel

WORKING CAPITAL MANAGEMENT

 WORKING CAPITAL MANAGEMENT (WCM) involves managing the firm’s current assets and current liabilities
in order to achieve a balance between risks (liquidity) and returns (profitability).
 The term ‘working capital’ generally refers to current assets only. For purposes of WCM, ‘working capital’
refers to the difference between current assets and current liabilities (i.e., net working capital):
✓ The minimum working capital requirement regardless of the seasonal variations in business operations is
called PERMANENT (fixed) working capital.
✓ When additional working capital is needed during the more active business season, such working capital
is called SEASONAL (variable or incremental) working capital.
 WORKING CAPITAL FINANCING refers to optimal level, mix and use of current assets and current liabilities.
Consider the following working capital financing policies:
1) CONSERVATIVE financing strategy a.k.a. relaxed policy: a company seeks to minimize liquidity risk by
maintaining a relatively high level of working capital. This policy reduces liquidity risk but is considered
less profitable due to more reliance on long-term financing, which incurs relatively higher financing costs.
2) AGGRESSIVE financing strategy a.k.a. restricted policy: operations are conducted with a minimum
amount of working capital. This policy enhances profitability by relying more on short-term debts rather
than long-term debts but is considered risky due to higher chances of short-term insolvency.
3) MODERATE financing strategy a.k.a. balanced or semi-aggressive or semi-conservative policy: working
capital maintained is relatively not too high (conservative) nor too low (aggressive).
4) MATCHING financing strategy a.k.a. self-liquidating or hedging policy: this policy is achieved by
matching the maturity of financing source with an asset’s useful life -- short-term assets are financed
with short-term liabilities; long-term assets are funded by long-term financing sources.
 WCM considers the level, liquidity, activity and structural component of working capital. A sound practice of
WCM would normally involve the following:
✓ Managing cash and its temporary investment efficiently. (Cash & Marketable Securities Management)
✓ Drafting and implementing effective credit and collection policies. (Receivable Management)
✓ Seeking favorable terms from suppliers and other short-term creditors. (Short-Term Credit Financing)
✓ Ensuring efficient manufacturing operations and sound material procurement. (Inventory Management)
CASH & MARKETABLE SECURITIES MANAGEMENT
 Four (4) reasons for holding cash: “Why would a firm hold cash when, being idle, it is a non-earning asset?”
1) TRANSACTION motive (Liquidity motive): cash is held to facilitate normal transactions of the business.
2) PRECAUTIONARY motive (Contingent motive): cash is held beyond the normal operating requirement to
provide for buffer against contingencies, such as slow-down in collection and possibilities of strikes.
3) SPECULATIVE motive: cash is held to avail of profit-making opportunities (e.g., sudden price drop).
4) CONTRACTUAL motive: cash is held as required by contracts or covenants (e.g., compensating balance).
 OPTIMAL CASH BALANCE (OCB), a.k.a. Economic Cash Quantity or Economic Conversion Size, is based on
the following formula under the BAUMOL model (named after the American economist William Baumol):
2DT Where: D → Annual Demand for Cash
OCB = T → Costs per Transaction
O O → Opportunity Cost of Holding Cash
Opportunity Costs = (OCB ÷ 2) x O Where: (OCB ÷ 2) → average cash balance
Transaction Costs = (D ÷ OCB) x T Where: (D ÷ OCB) → number of transactions per year
➢ “OCB” is the optimal amount of cash to be raised by selling marketable securities or by borrowing
➢ “D” is total amount of new cash needed for transactions during the year
➢ “T” refers to the fixed costs of trading securities or cost of borrowing
➢ “O” refers to the rate of return foregone on marketable securities or the cost of borrowing
 The Baumol model, like its pattern EOQ, assumes that the demand for cash is spread evenly throughout the
year. When there is an irregularity of cash payment, OCB is computed using another formula based on the
MILLER-ORR model where OCB or ‘cash return point’ is achieved when the level of cash reaches an upper
limit/maximum amount or a lower limit/minimum amount.
 CASH BREAK-EVEN POINT (BEP) is the sales level at which total cash inflows is equal to total cash outflows.
➢ Cash BEP in Unit Sales = Fixed Payments ÷ Unit Contribution Margin
➢ Cash BEP in Peso Sales = Fixed Payments ÷ Contribution Margin Ratio
 CASH CONVERSION CYCLE (CCC) a.k.a. cash flow cycle is the average time from the point cash is used to
pay for raw materials until cash is collected on the accounts receivable associated with the goods produced
with those raw materials. CCC must be distinguished from the NORMAL OPERATING CYCLE (NOC), which is
the length of time within which the firm purchases or produces inventory, sells it and receives cash.
NOC = Average Age of Inventory + Average Age of Receivable
CCC = Average Age of Inventory + Average Age of Receivable – Average Age of Payable
(Alternative: CCC = NOC – Average Age of Payable)
Where: Formula Other Name(s)
Average Age of Inventory Inventory ÷ CGS* per day Inventory Conversion Period, Days Sales in Inventory
Average Age of Receivable Receivables ÷ Sales per day Receivable Collection Period, Days Sales Outstanding
Average Age of Payable Payables ÷ Purchases per day Payable Deferral Period, Days Payables Outstanding
* “Sales per day” may be used in lieu of CGS per day -- the intention is to use an amount in proportion to
unit sales. ‘Average age’ ratios may also be computed using TURNOVER ratios under MS-13 on FS Analysis.

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY
WORKING CAPITAL MANAGEMENT MS-10
 CASH MANAGEMENT STRATEGIES that help shorten the CCC:
✓ Accelerating collections (e.g., prompt billing, cash discounts, online collection, lockbox)
➢ LOCKBOX SYSTEM requires customers to mail payments to a post office box in a specific location, a
local bank then collects the checks from the box and deposit them promptly in the client’s account.
✓ Reducing precautionary idle cash (e.g., readily available line of credit, well-thought cash budgets)
➢ LINE of CREDIT is a predetermined borrowing limit that an entity can use at any time -- the borrower
can take money out as needed until the limit is reached, and as money is repaid, it can be borrowed
again in the case of an open line of credit.
✓ Slowing disbursements (e.g., payment thru drafts, zero-balance accounts, playing the float)
➢ ZERO-BALANCE ACCOUNT (ZBA) requires checks to be written from special disbursement accounts
having zero-peso balance with no minimum maintaining balance required. Funds are automatically
transferred from a master account when a check drawn from a ZBA is presented.
 FLOAT is the difference between cash balance per BANK and cash balance per BOOK as of a certain period,
primarily due to outstanding checks and other similar reasons. Two types of floats are:
✓ POSITIVE or DISBURSEMENT Float: bank balance > book balance
Possible cause: outstanding checks issued by the firm that have not cleared yet.
✓ NEGATIVE or COLLECTION Float: book balance > bank balance
1. MAIL Float – amount of customers’ payments that have been mailed by customers but not yet received
by the seller-company
2. PROCESSING Float – amount of customers’ payments that have been received by the seller but not
yet deposited.
3. CLEARING Float – amount of customers’ checks that have been deposited but have not cleared yet.
Good cash management suggests that positive float should be maximized while negative float be minimized
or, if possible, eliminated.
 MARKETABLE SECURITIES are short-term money market instruments that can easily be converted to cash.
Some of the common examples where an entity may invest its temporary idle funds:
✓ CERTIFICATES of DEPOSITS (CD) – savings deposits at financial institutions (e.g., time deposit)
✓ MONEY MARKET FUNDS – shares in a fund that purchases higher-yielding bank CDs, commercial paper,
and other large-denomination, higher-yielding securities
✓ GOVERNMENT SECURITIES
➢ Treasury bills – debt instruments representing obligations of the National Government issued by the
central bank and usually sold at a discount through competitive bidding
➢ CB Bills or Certificates of Indebtedness (CBCIs) – represent indebtedness by the Central Bank.
✓ COMMERCIAL PAPERS – short-term, unsecured, material promissory notes issued by private corporations
with relatively high credit standing.
✓ REPURCHASE AGREEMENTS (Repos) – investment in loans with a commitment to resell the security at
the original contract price plus an agreed interest income for the holding period.
✓ BANKERS’ ACCEPTANCES – a draft drawn on a specific bank by a firm that has an account with the bank,
which if accepted by the bank becomes a negotiable instrument and is available for investments.
 Factors considered in choosing marketable securities include:
✓ RISKS
➢ Default risk – chances that issuer may not be able to pay interest or principal on time.
➢ Inflation risk – danger that inflation will reduce the investment’s real value.
➢ Interest rate risk – fluctuations in prices caused by changes in market interest rates.
✓ MARKETABILITY – refers to how quickly a security can be sold before maturity date without a significant
price concession.
✓ RETURNS – an entity is willing to assume more risks given a higher expected return on investment.
✓ TERM or MATURITY – maturity dates should coincide, whenever possible, with the date at which the firm
needs cash, or when the firm will no longer have cash to invest.
✓ TAXES – some marketable securities do not require payment of taxes, such as municipal bonds.
RECEIVABLES MANAGEMENT
 Receivable management refers to the set of policies, procedures, and practices employed by a company with
respect to managing sales on account or credit sales.
 Receivable management encompasses the evaluation of customer’s credit worthiness and risk, establishing
sales terms and credit policies, and designing an appropriate receivable collection process.
✓ CREDIT STANDARD: consider the “5 C’s” in determining which customer shall be granted credit and how
much will the credit limit be. To wit:
➢ Character – customers’ willingness to pay
➢ Capacity – customers’ ability to generate cash flows
➢ Capital – customers’ financial sources (i.e., net worth)
➢ Conditions – current economic or business conditions
➢ Collateral – customer pledges to secure debt.
✓ CREDIT TERM refers to the (1) credit period extended to customer to encourage sales and (2) cash
discount offered to encourage prompt payment. Costs associated with credit terms that are considered
include cash discounts, credit analysis and collections costs, bad debt losses and financing costs.
✓ COLLECTION PROGRAM: shortening the average collection period means less investment in receivable
(low opportunity costs) and less chances of delinquency and defaults, but may result to loss of customers
due to less favorable terms.
[Meaningful ratios useful in receivable management include receivable turnover, receivable collection
period or days sales outstanding. These ratios are covered in MS-13 on FS Analysis.]

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY
WORKING CAPITAL MANAGEMENT MS-10
INVENTORY MANAGEMENT
 The central issue in inventory management is to maintain an optimum investment in inventories that considers
a risk-reward relationship based on the following tradeoff: overinvesting in inventory avoids shortages but
incurs costs vs. underinvesting in inventory saves on costs but increases the risk of stock-out or shortages.
 Two general approaches to inventory management:
✓ MATERIALS REQUIREMENT PLANNING (MRP) is used to determine the quantity and order timing of raw
materials based on sales forecast and scheduled production of finished goods.
✓ “JUST-IN-TIME” (JIT) is a demand-pull system that focuses on real usage, rather than sales forecast (as
opposed to MRP) in order to maximize space, minimize insurance costs, eliminate waste (non-value-
added activities), lower inventory carrying costs, and free-up capital.
MRP is a computer-based system that focuses on meeting requirements of the ‘projected’ usage or demand
while JIT is focused on the current, ‘real’ usage or demand while the system runs.
 MRP must be distinguished from MANUFACTURING RESOURCE PLANNING (MRP-II). MRP II evolved from early
MRP systems by including the integration of additional data, such as employee and financial needs. MRP-II is
a closed-loop system that integrates various functional areas of a manufacturing company (e.g., inventories,
production, sales and cash flows).
 MRP and MRP-II must be distinguished from ENTERPRISE RESOURCE PLANNING (ERP), which integrates the
information systems of the whole enterprise where organizational operations are inter-connected while the
organization itself is connected with its customers and suppliers.
 Activity-Based Costing [covered in AFAR] must be distinguished from inventory management’s ABC
Classification system. ABC Classification system is an inventory categorization method based on the Pareto
Principle in economics -- “In any group, there are significant few and insignificant many.”
✓ A items – high-value items (relatively few in number) requiring highest possible control
✓ B items – medium-value items requiring normal or moderate control
✓ C items – low-value items (relatively many in number) requiring the simplest possible control
 INVENTORY MODEL addresses inventory management issues based on these questions:
1) “How many units should be ordered?”
ECONOMIC ORDER QUANTITY (EOQ) refers to the order size (number of units) that minimizes the sum
of ordering costs and carrying costs.
➢ CARRYING COSTS – as order size increases, total carrying costs would also increase.
Examples: Storage, insurance, spoilage, obsolescence, security, record keeping, interest foregone
➢ ORDERING COSTS – as order size increases, total ordering costs would also decrease.
Examples: Delivery, inspection, handling, purchasing, processing, receiving, quantity discount lost

2DO Where: D → Annual Demand or usage in units

EOQ = O → Costs of placing one Order
C C → Cost of Carrying one unit for one year
Carrying Costs = (EOQ ÷ 2) x C Where: (EOQ ÷ 2) → Average inventory in units
Ordering Costs = (D ÷ EOQ) x O Where: (D ÷ EOQ) → Number of orders per year
If safety stock is maintained, then average inventory = (EOQ ÷ 2) + safety stock
Assumptions & limitations of EOQ model:
1. Demand occurs evenly at a constant rate throughout the year.
2. For each order, units are received in a single delivery and lead time does not vary (constant).
3. The unit cost of the inventory is constant; hence, there can be no quantity discounts.
4. There is no limit as to the order size or the number of units that may be ordered.
2) “When should the units be reordered?”
REORDER POINT refers to the number of units at which goods should be re-ordered to minimize on the
sum of carrying costs and stock-out costs.
➢ STOCK-OUT COSTS are opportunity costs and other costs incurred when inventory units run out-of-
stock (e.g., lost contribution margin on sales)
Reorder Point = Delivery Time Stock + Safety Stock
(Alternative Formula: Reorder Point = Maximum Lead Time x Average Usage per Unit of Time)
Where: Delivery Time Stock = Normal Lead Time x Average Usage per Unit of Time
Safety Stock = (Maximum Lead Time – Normal Lead Time) x Average Usage per Unit of Time
LEAD TIME is period from the time an order is placed until such time the same order is received.
➢ Normal/Average lead time - this refers to the usual delay in the receipt of ordered goods
➢ Maximum lead time - this adds to normal lead time a reasonable allowance for further delay
SAFETY STOCK (a.k.a. buffer stock) refers to the extra number of units maintained to protect against
stock-out costs during periods of uncertain lead time and demand. Alternatively, safety stock may be
computed using the demand-based formula: (Maximum Usage – Normal Usage) x Normal Lead Time
 Applications of EOQ:
✓ When used for production, EOQ becomes the ECONOMIC LOT SIZE (ELS):
Where: P → Annual Production in units
2PS
ELS = S → Setup costs per batch of production
C C → Cost of Carrying one unit for one year
✓ When used for cash management, EOQ becomes the OPTIMAL CASH BALANCE or “Baumol Model” as cited
on page 1.

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY
WORKING CAPITAL MANAGEMENT MS-10
SHORT-TERM CREDIT FINANCING
 Common sources of short-term funds include:
✓ UNSECURED CREDITS (e.g., accruals, trade credit and commercial papers)
✓ SECURED LOANS (e.g., receivable financing – pledging and factoring)
(e.g., inventory financing – blanket lien, trust receipts, warehouse receipts)
✓ BANKING CREDITS (e.g., term loan, line of credit, revolving credit agreement)
 Factors considered in selecting sources of short-term funds:
✓ COST – the effective costs of various credit sources.
✓ AVAILABILITY – the readiness of credit as to when needed and how much is needed.
✓ INFLUENCE – the influence of use of one credit source and availability of other sources of financing.
✓ REQUIREMENT – additional covenants unique to various sources of financing (e.g., loans).
 Cost of short-term funds (Assume a 360-day year):
✓ Cost of TRADE CREDIT with supplier*:
Discount Rate 360 Days
COST = X
100% - Discount Rate Credit Period - Discount Period
* This type of financing cost is caused by foregoing cash discounts (opportunity cost).
✓ Cost of BANK LOANS (Effective Annual Rate):
Interest 360 Days
COST = X
Net Proceeds Loan Term
➢ If loan does not require a compensating balance:
▪ Non-discounted: net proceeds = face value
▪ Discounted: net proceeds = face value less interest
➢ If loan requires a compensating balance (CB):
▪ Non-discounted: net proceeds = face value less CB
▪ Discounted: net proceeds = face value less interest less CB
✓ Cost of COMMERCIAL PAPERS
Interest + Issue Costs 360 Days
COST = X
Face value – Interest – Issue Costs Paper Term
✓ Cost of FACTORING RECEIVABLES
Interest + Factor’s Fee 360 Days
COST = X
Face value – Interest – Factor’s Fee – Factor’s Holdback Remaining Maturity Period

EXERCISES: WORKING CAPITAL MANAGEMENT

1. Working Capital & Liquidity Ratios

Given the partial balance sheet information of South Korea Company:
Cash P 16,000 Accounts Payable P 10,000
Accounts Receivable 14,000 Accrued Payroll 7,000
Inventory 20,000 Current Tax Liability 3,000
Fixed Assets 50,000 Bonds Payable 25,000
Bonds will mature in 10 years.
REQUIRED:
A) Determine the: (1) net working capital (2) current ratio (3) quick or acid-test ratio
B) If the entire accounts payable are paid in cash, what is the new current ratio?
C) If a short-term loan of P 10,000 is obtained from a bank, what is the new current ratio?

2. Working Capital Policy: Conservative vs. Aggressive

Aussie Company has P 1,000,000 in current assets, 40% of which are considered permanent current assets.
In addition, the firm has P 600,000 invested in fixed assets. In the current year, the company reported
earnings of P 200,000 before considering the following interests and tax charges:
✓ Short-term financing: 5%
✓ Long-term financing: 10%
✓ Tax rate: 20%
Plan A – Aussie finances all fixed assets and half of its permanent current assets with long-term financing.
Plan B – Aussie finances all fixed assets and permanent assets plus half of its temporary current assets with
long-term financing.
REQUIRED:
A) How much is the difference in earnings after tax between Plan A and Plan B?
B) Which working capital policy between Plan A and Plan B is considered conservative? aggressive?

3. Optimal Cash Balance – Baumol Model

Canada Corporation is expecting to have total payments of P 1,800,000 for one year, cost per transaction
amounted to P 25, and the interest rate of marketable securities is 10%.
A) What is the company’s optimal initial cash balance that minimizes total costs?
B) What is the total number of transactions or cash conversions that will be required per year?
C) How frequent in days shall Canada do the transaction or cash conversion within the year?
D) What will be the average cash balances for the period?
E) How much is the total cost of maintaining cash balances?

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY
WORKING CAPITAL MANAGEMENT MS-10
4. Cash Conversion Cycle
NZ Company is concerned about managing cash efficiently. On the average, inventories have an age of 90
days, and accounts receivable are collected in 60 days. Accounts payable are paid approximately 30 days
after they arise. NZ spends at a constant rate P 24 million on operating-cycle investments each year.
REQUIRED:
A) How long in days is the normal operating cycle?
B) How long in days is the cash conversion cycle?
C) What is the number of cash conversion cycles in one year (360 days)?
D) How much amount of resources is needed to support the cash conversion cycle?

5. Float & Lockbox System

SG Company has daily cash receipts of P 120,000. A recent analysis of its collection indicated that customer’s
payments were in the mailing system for an average of 2.5 days. Once received, the payments are processed
in 1.5 days. After payments are deposited, it takes an average of 5 days for these receipts to clear the
banking system. SG considers adopting a lockbox system that will reduce the collection float time to 7 days.
Rate of return is 10%
REQUIRED:
A) How much is the reduction in collection float associated with implementing the lockbox system?
B) If the lockbox system costs P 2,500 per month, should the system be implemented?
C) What maximum amount is SG Company willing to pay for the lockbox system for one year?

6. Average Investment in Accounts Receivable

Japan Corporation sells on terms of 2/10, n/30. 70% of customers normally avail of the discounts. Annual
sales are P 9,000,000, 80% of which is made on credit. Cost is approximately 75% of sales.
REQUIRED:
A) Average balance of accounts receivable B) Average investment in accounts receivable.

7. Collection Policy - Cash Discount

Taiwan Company presents the following information:
 Annual credit sales: P 36,000,000
 Collection period: 2 months
 Rate of return: 15%
Taiwan considers changing its credit term from ‘n/30’ to ‘4/10, n/30’ with the following expected results:
(1) 30% of its customers will take advantage of the discount while sales remain constant.
(2) Collection period is expected to decrease from two months to one month.
REQUIRED:
What is the net advantage (disadvantage) of implementing the proposed discount?

8. Credit Policy – Relaxation of Credit Standards & Extension of Credit Period

Thailand Corporation reports the following information:
A) Selling price per unit P 10
B) Variable cost per unit P8
C) Total fixed costs P 120,000
D) Annual credit sales 240,000 units
E) Collection period 3 months
F) Rate of return 25%
Thailand considers relaxing its credit standards and extending its credit period. The following results are
expected: (1) sales will increase by 25%; (2) collection costs will increase by P 40,000; (3) bad debt losses
are expected to be 5% on the incremental sales; and (4) collection period will increase to 4 months.
REQUIRED:
What is the net advantage (disadvantage) of implementing the relaxation of credit standards and
extension of credit period?

9. Economic Order Quantity, Carrying Costs & Ordering Costs

Lee Do Hyun Company requires 40,000 units for its signature product 18-Again. The units will be used evenly
throughout the year. The cost to place one order is P 100 while the cost to carry the inventory for one year
is P 2 per unit.
REQUIRED:
A) Determine the optimal order quantity (EOQ)
B) How many and how often orders should be placed within a year?
C) Determine the average inventory in units
D) Determine the annual inventory carrying costs
E) Determine the annual inventory ordering costs

10. Reorder Point & Safety Stock

Kim Seon Ho purchases 7,200 units of its product “Cha-Cha-Cha” every year. Kim Seon Ho works 360 days
per year. The normal purchase lead time is 10 working days while maximum lead time is 15 working days.

REQUIRED: Determine the following:

A) Safety (buffer) stock B) Reorder point

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY
WORKING CAPITAL MANAGEMENT MS-10
11. Stock-Out Costs
Each stock-out of a product sold by Rachel Park Company costs P 2,000 per occurrence. The carrying cost
per unit of inventory is P 5 per year and the company orders 18 times a year at a cost of P 200 per order.
The probability of a stock-out at various levels of safety stock is:

Units of Safety Stock Probability of a Stock-Out

0 50%
200 30%
400 15%
600 5%
800 1%
What is the optimal level of safety stock?
a. 200 units c. 600 units
b. 400 units d. 800 units
12. Economic Lot Size
SM (Soriano-Manuel) Bookstore publishes a book about RFBT. SM prints 20,000 copies of the book evenly
throughout the year. The set-up cost is P 300 while the optimal production run (economic lot size) is 2,000.
REQUIRED:
How much is the unit carrying cost of the book per year?
13. Short-Term Credit Financing – Trade Credit
Baguio Trading purchases merchandise for P 200,000, 2/10, n/30.
REQUIRED:
A) The annual cost of trade credit.
B) The annual cost of trade credit if term is changed to 1/15, n/20.
14. Short-Term Credit Financing – Bank Loans
Cebu Trading was granted a 180-day P 200,000 bank loan with 12% stated interest.
REQUIRED: The effective annual rate, under the following cases:
A) Cebu receives the entire amount of P 200,000.
B) Cebu granted a discounted loan.
C) Cebu is required to maintain a compensating balance of P 10,000.
D) Cebu is required to maintain a compensating balance of 10% under a discounted loan.

15. Short-Term Credit Financing – Commercial Paper

CDO Company plans to sell a 180-day commercial paper amounting to P 100,000,000, which it expects to
pay a discounted interest of 12% per annum. CDO expects to incur P 100,000 in dealer placement fees and
paper issue costs.

REQUIRED:
Determine the effective cost of CDO’s credit.

16. Short-Term Credit Financing – Receivable Factoring

Davao Company has P 200,000 in receivable that carries 30-day credit term, 2% factor’s fee, 6% holdback
reserve and an interest of 12% per annum on advances.
REQUIRED:
A) How much is the cash proceeds from factoring the receivable?
B) What is effective annual rate of financing thru factoring the receivable?

WRAP-UP EXERCISES (MULTIPLE-CHOICE QUESTIONS)

1. Working capital management is concerned about the trade-off between

a. Return and financial risk
b. Default risk and conservatism
c. Current ratio and return on equity
d. Profitability and risk of technical short-term insolvency
2. Which of the following characteristics are generally associated with a CONSERVATIVE financial policy?
a. Low current assets relative to sales and low current liabilities relative to total assets
b. Low current assets relative to sales and high current liabilities relative to total assets
c. High current assets relative to sales and low current liabilities relative to total assets
d. High current assets relative to sales and high current liabilities relative to total assets
3. The PRECAUTIONARY motive for holding cash is for:
a. Daily operating requirements
b. Safety and emergency reasons
c. Compensating balance requirements
d. Buying goods before prices rise to higher levels
4. The basic strategies that must be employed in managing cash include all the following, EXCEPT:
a. Collecting accounts receivable as quickly as possible without damaging customer rapport
b. Paying accounts payable as late as possible without damaging the firm’s credit rating
c. Turning over inventory as quickly as possible, avoiding stockouts
d. Operating in a fashion that requires maximum cash

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY
WORKING CAPITAL MANAGEMENT MS-10
5. A working capital technique that increases the payable float and therefore delays the outflow of cash is
a. A draft c. Electronic fund transfer (EFT)
b. A lockbox system d. Electronic data interchange (EDI)
6. A firm has an average age in inventory of 72 days, an average collection period of 45 days, and an
average payment period of 27 days. What is the firm’s cash conversion cycle?
a. 90 days c. 117 days
b. 99 days d. 144 days
7. Changing a firm’s credit terms from 2/20, net/60 to 2/10, net/30 will generally
a. Increase sales but decrease the average collection period
b. Reduce sales but increase the average collection period
c. Increase sales and the average collection period
d. Reduce sales and the average collection period
8. A computerized inventory system that simulates needed materials for the finished product, and then
compares production needs with available inventory balance to determine when orders should be placed.
a. EOQ system c. Just-In-Time system
b. Electronic Data Interchange d. Material Requirements Planning System
9. In ABC classification system of inventory control, class “A” inventory consists of
a. Many low-value items c. Few low-value items
b. Many high-value items d. Few high-value items
10. The Economic Order Quantity (EOQ) is unaffected by the
a. Cost of placing and receiving an order
b. Cost of obtaining capital as carrying costs
c. Lead-time from order placement until order fulfillment
d. Number of units expected to be sold or used during the year
11. The purpose of economic order quantity (EOQ) is to minimize the
a. Safety stock
b. Inventory quantities
c. Sum of the ordering costs and holding costs
d. Sum of the demand costs and the back-log costs
12. Which of the following is not considered a cost of carrying inventory?
a. Insurance c. Shipping and handling
b. Property tax d. Depreciation and obsolescence
13. The ordering costs associated with inventory management include
a. Shipping costs, obsolescence, setup costs, and capital invested
b. Insurance costs, purchasing costs, shipping costs, and spoilage
c. Obsolescence, setup costs, quantity discounts lost, and storage costs
d. Purchasing costs, shipping costs, setup costs, and quantity discounts lost
14. In inventory management, the safety stock will tend to increase if the
a. Carrying cost increases c. Variability of the lead time increases
b. Cost of running out of stock decreases d. Variability of the usage rate decreases
15. Which of the following forms of short-term borrowing is a secured credit?
a. Line of credit c. Commercial paper
b. Chattel mortgage d. Banker’s acceptances
16. Using a 360-day year, what is the opportunity cost to a buyer of not accepting terms 3/10, n/45?
a. 22.27% c. 55.67%
b. 31.81% d. 101.73%
17. A company has just borrowed P 2,000,000 from a bank. The stated rate of interest is 10%. If the loan is
discounted and repayable in 1 year, then what is the effective rate of the loan?
a. 8.89% c. 10.00%
b. 9.09% d. 11.11%
SELF-TEST QUESTIONS – with suggested answers
(Sources: CMA/CIA/RPCPA/AICPA/Various test banks)
1. The portion of a firm’s current assets financed with long-term funds may be called
D a. Inventory c. Accounts receivable
b. Cash and cash equivalents d. Net working capital
2. Which of the following is strictly not a use of working capital?
B a. Repurchase of common stock c. Purchase of equipment on account
b. Purchase of inventory on account d. Repayment of long-term debt
3. The net working capital of Philippines Company at December 31, 2022 was P 10,000,000. Selected information for the
year 2023 for Philippines Company is as follows:
Working capital provided from operations P 1,700,000
Capital expenditures 3,000,000
Proceeds from short-term borrowings 1,000,000
Proceeds from long-term borrowings 2,000,000
Payments on short-term borrowings 500,000
Payments on long-term borrowings 600,000
Proceeds from issuance of common stock 1,400,000
Dividends paid on common stock 800,000
What is the net working capital at December 31, 2023?
A a. P 10,700,000 c. P 11,500,000
b. P 11,200,000 d. P 12,000,000

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4. China Co. had income before taxes of P 60,000. Included in this amount was depreciation of P5,000, a charge of P 6,000
for the amortization of bond discounts, and P 4,000 for interest expense. What is the estimated cash flow for the period?
D a. P 49,000 c. P 66,000
b. P 60,000 d. P 71,000
5. USA Co. has an acid test ratio of 1.5 to 1.0. Which of the following will cause this ratio to deteriorate?
B a. Payment of cash dividends previously declared
b. Borrowing short-term loan from a bank
c. Sale of inventory on account
d. Sale of equipment at a loss
6. It is the policy of a company that the current ratio cannot fall below 1.5 to 1.0. Its current liabilities are P 400,000 and
the present current ratio is 2 to 1. How much is the maximum level of new short-term loans it can secure without
violating the policy?
A a. P 400,000 c. P 266,667
b. P 300,000 d. P 800,000
7. A firm's current ratio is currently 2.2 to 1. Management knows it cannot violate a working capital restriction contained in
its bond indenture. If the firm's current ratio falls below 2 to 1, technically it will have defaulted. If current liabilities are
P 200,000,000, what is the maximum new commercial paper that can be issued to finance inventory expansion?
B a. P 20 million c. P 180 million
b. P 40 million d. P 240 million
8. Which one of the following transactions would increase the current ratio and decrease net profit?
B a. A stock dividend is declared
b. Vacant land is sold for less than the net book value
c. An income tax payment due from the previous year is paid
d. Uncollectible accounts receivable are written off against the allowance account
9. Australia Corporation has 100,000 shares of stock outstanding. Below is part of Australia’s Statement of Financial Position
for the last fiscal year.
Statement of Financial Position as of December 31 – Selected items
Cash P 455,000
Accounts receivable 900,000
Inventory 650,000
Prepaid assets 45,000
Accrued liabilities 285,000
Accounts payable 550,000
Current portion, long-term notes payable 65,000
What is the maximum amount Australia can pay in cash dividends per share and maintain current ratio of 2 to 1? Assume
that all accounts other than cash remain unchanged.
B a. P 2.05 c. P 3.35
b. P 2.50 d. P 3.80
10. As a company becomes more conservative in working capital policy, it would tend to have a (an)
B a. Decrease in acid test ratio
b. Increase in the ratio of current assets to units of output
c. Increase in the ratio of current liabilities to non-current liabilities
d. Increase in funds invested in common stock and a decrease in funds invested in securities
11. The firm’s financing requirement can be separated into
A a. Seasonal and permanent c. Current liabilities and long-term funds
b. Current assets and fixed assets d. Current liabilities and long-term debts
12. The working capital financing policy that subjects the firm to the greatest risk of being unable to meet the firm’s maturing
obligations is the policy that finances (where: CA = current assets)
D a. Temporary CA with long-term debts c. Permanent CA with long-term debts
b. Fluctuating CA with short-term debts d. Permanent CA with short-term debts
13. Which of the following actions would not be consistent with good working capital management?
A a. Minimize the use of float
b. Increased synchronization of cash flows
c. Use of checks and drafts in disbursing funds
d. Maintaining an average cash balance equal to that which minimizes total cost
14. Determining the appropriate level of working capital for a firm requires
D a. Evaluating the risks associated with various levels of fixed assets and the types of debt used to finance
these assets
b. Changing the capital structure and dividend policy of the firm
c. Maintaining short-term debt at the lowest possible level because it is generally more expensive than
long-term debt
d. Offsetting the benefit of working capital against the probability of technical insolvency
15. The most direct way to prepare a cash budget for a manufacturing firm is to include
D a. Projected sales, credit terms, and net income
b. Projected net income, depreciation and goodwill amortization
c. Projected purchases, percentages of purchases paid, and net income
d. Projected sales and purchases, percentages of collections, and terms of payments

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WORKING CAPITAL MANAGEMENT MS-10
16. Shown below is a forecast of sales for Europe Inc. for the first 4 months of the year (amounts in thousands of pesos).
January February March April
Cash sales P 15 P 24 P 18 P 14
Sales on credit 100 120 90 70
On average, 50% of credit sales are paid for in the month of sale, 30% in the month following the sale, and the remainder
is paid 2 months after the month of sale. Assuming no bad debts, what is the expected cash inflow for Europe in March?
C a. P 138,000 c. P 119,000
b. P 122,000 d. P 108,000
17. Asia Inc. has a pool of cash that it uses to pay bills. When the cash is exhausted, it replenishes its pool by selling T-bills.
The firm disburses P 600,000 in cash every year, and every sale of T-bills costs P 60. The current risk-free rate is 8%.
What is the optimal cash balance for Asia?
C a. P 27,932 c. P 30,000
b. P 48,530 d. P 37,546
18. A firm needs a total of P 30,000,000 in new cash for transaction purposes. The annual interest rate on marketable
securities is 10% and the brokerage fee cost per transaction of selling securities to replenish cash is P 1,000. Which of
the following is closest to the firm’s optimal average cash balance?
B a. P 353,432 c. P 774,597
b. P 387,298 d. P 790,213
19. Africa, Inc. has P 2 million invested in T-bills yielding 8% per annum. This investment will satisfy the firm’s need for
funds during the coming year. It costs P 50 to sell these bills. If Africa needs P 166,667 a month, how frequently should
the company sell off T-bills?
B a. About every 3 days c. About every 15 days
b. About every 9 days d. About every 18 days
20. A firm has an average age in inventory of 60 days, an average collection period of 45 days, and an average payment
period of 30 days. What is the number of days in the cash flow cycle?
D a. 135 days c. 90 days
b. 105 days d. 75 days
21. The company’s cash flow cycle extends up to 50 days. Receivables age is for 20 days. Average age in inventory is twice
as long as days’ receivable. For how long is the company’s payable deferral period?
A a. 10 days c. 5 days
b. 20 days d. 15 days
22. Assume that each day a company writes and receives checks totaling P 10,000. If it takes 5 days for the checks to clear
and be deducted from the company’s account, and only 4 days for the deposits to clear, what is the float?
C a. (P 10,000) c. P 10,000
b. P 0 d. P 50,000
23. Arctic is a retail mail order firm that currently uses a central collection system. An average of 6 days is required for mailed
checks to be received, 3 days for Arctic to process them, and 2 days for the checks to clear through its bank. A proposed
lockbox system would reduce the mailing and processing time to 2 days and the check-clearing time to 1 day. Arctic has
an average daily collection of P 150,000. If Arctic adopts the lockbox system, its average cash balance will increase by
A a. P 1,200,000 c. P 600,000
b. P 750,000 d. P 450,000
24. America Company is considering implementing a lockbox system at a cost of P 20,000 per quarter. Annual sales are P
90,000,000, and the lockbox system will reduce collection time by 3 days. If America can invest funds at 8%, should it
implement lockbox system? (Assume a 360-day year)
C a. Yes, savings of P 140,000 per year c. No, loss of P 20,000 per year
b. Yes, savings of P 60,000 per year d. No, loss of P 60,000 per year
25. A firm has daily cash receipts of P 100,000 and collection time of 2 days. A bank has offered to reduce the collection
time on the firm’s deposit by 2 days for a monthly fee of P 500. If money market rates are expected to average 6%
during the year, the net annual benefit (loss) from having this service is
C a. P 0 c. P 6,000
b. P 3,000 d. P 12,000
26. Peru Company is a newly established firm and the owner is deciding what type of checking account to open. Peru is
planning to keep a P 500 minimum balance in the account for emergencies and plans to write roughly 80 checks per
month. The bank charges P 10 per month and P 0.10 per check charge for a standard business checking account with
no minimum balance. Peru also has the option of a premium business balance that requires a P 2,500 minimum balance
but has no monthly fees or per check charges. If cost of funds is 10%, which account should Peru choose?
D a. Standard account, because the savings is P 34 per year
b. Premium account, because the savings is P 34 per year
c. Standard account, because the savings is P 16 per year
d. Premium account, because the savings is P 16 per year
27. A method of delaying the disbursement of cash by a corporation with a liquidity problem would be to:
D a. Install a lockbox system
b. Utilize a concentration banking program
c. Take as many cash discounts as possible
d. Pay its bills using bank drafts
28. When managing cash and short-term investments, a corporate treasurer is primarily concerned with
D a. Maximizing rate of return
b. Minimizing taxes
c. Investing in treasury bonds since they have no default risk
d. Liquidity and safety

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WORKING CAPITAL MANAGEMENT MS-10
29. Investment instruments used to invest temporarily idle cash balances should have the following characteristics:
C a. High expected return, readily marketable, and no maturity date
b. Low default risk, low marketability, and a short term to maturity
c. Low default risk, readily marketable, and a short term to maturity
d. High expected return, low marketability, and a short term to maturity
30. China Inc. has a majority of its customers located in Metro Manila. Tibetan, a major retail bank, has agreed to provide a
lockbox system to China at a fixed fee of P 50,000 per year and a variable fee of P0.50 for each payment processed by
the bank. On average, China receives 50 payments per day, each averaging P 20,000. With the lockbox system, the
company’s collection float will decrease by 2 days. The annual interest rate on money market securities is 6%. If China
makes use of the lockbox system, what would be the net benefit to the company? (Use 365 days per year)
C a. P 50,000 c. P 60,875
b. P 59,125 d. P 120,000
31. The primary objective in management of accounts receivable is
A a. To achieve that combination of sales volume, bad debt experience, and receivables turnover that
maximizes the profits of the firm
b. To coordinate the activities of manufacturing, marketing, and financing so that the firm can maximize
its profits
c. To provide the treasurer of the corporation with sufficient cash to pay for the bills on time
d. To realize no bad debts because of the opportunity costs involved
32. The average collection period for a firm measures the number of days
A a. After a typical credit sale is made until the firm receives the payment
b. For a typical check to ‘clear’ through the banking system
c. Beyond the end of the credit period before a typical customer payment is received
d. Before a typical account becomes delinquent
33. Russia, Inc. sells with terms 3/10, net 30 days. Gross sales for the year are P 2,400,000 and the collections department
estimates that 30% of the customers pay on the tenth day and take discounts; 40% pay on the thirtieth day; and the
remaining 30% pay, on the average, 40 days after the purchase. Assuming 360 days per year, what is the average
collection period?
B a. 40 days c. 20 days
b. 27 days d. 15 days
34. An increase in sales resulting from an increased cash discount for prompt payment would be expected to cause a(n)
C a. Increase in the operating cycle c. Decrease in the cash conversion cycle
b. Decrease in purchase discounts taken d. Increase in the average collection period
35. England Company has an inventory conversion period of 60 days, a receivable conversion period of 35 days, and a
permanent cycle of 26 days. If its sales for the period just ended amounted to P 972,000, what is investment in accounts
receivable? (Assume 360 days in a year)
D a. P 72,450 c. P 85,200
b. P 79,600 d. P 94,500
36. Italy sells to retail stores on credit terms of 2/10, n/30. Daily sales average 150 units at a price of P 300 each. Assuming
that all sales are on credit and 60% of its customers take the discount and pay on day 10 while the rest of the customers
pay on day 30, what is the amount of Italy’s accounts receivable?
D a. P 1,350,000 c. P 900,000
b. P 990,000 d. P 810,000
37. Mexico Company has the opportunity to increase annual sales by P 1 million by selling to new riskier customers. It has
been estimated that uncollectible expenses would be 15% and collection costs, 5%. The manufacturing and other selling
costs are 70% of sales and corporate tax rate is 35%. What will be effect on the after-tax profit?
C a. Increase by P 35,000 c. Increase by P 65,000
b. Increase by P 97,500 d. Remain the same
38. A company’s budgeted sales for the coming year are P 96 million, of which 80% are expected to be credit sales at terms
of n/30. The company estimates that a proposed relaxation of credit standards would increase credit sales by 30% and
increase the average collection period from 30 to 45 days. Based on a 360-day year, the proposed relaxation of credit
standards would result to an increase in AR balance by
B a. P 6,880,000 c. P 2,880,000
b. P 6,080,000 d. P 1,920,000
39. Singapore Corporation plans to tighten its credit policy. Below is the summary of changes:
OLD policy NEW policy
Average number of days collection 75 50
Ratio of credit sales to total sales 70% 60%
Projected sales for the coming year are P 50 million and it is estimated that the company’s credit sales to be 5% less if
the new policy is implemented. Assuming a 360-day year, what is the effect of the new policy on accounts receivable?
A a. P 3,333,333 decrease c. P 6,500,000 decrease
b. P 3,817,445 decrease d. P 18,749,778 increase
40. Iran Computers believes that is collection costs could be reduced through modification of collection procedures. This
action is expected to result in a lengthening of the average collection period from 28 days to 34 days; however, there
will be no change in uncollectible accounts. The company’s budgeted credit sales for the coming year are P 27,000,000,
and short-term interest rates are expected to average 8%. To make the changes in collection procedures cost beneficial,
what would be the minimum savings in collection costs (using a 360-day year) for the coming year?
B a. P 30,000 c. P 180,000
b. P 36,000 d. P 360,000

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WORKING CAPITAL MANAGEMENT MS-10
41. A company with P 4.8 million in credit sales per year plans to relax its credit standards, projected to increase credit sales
by P 720,000. The company’s average collection period for new customers is expected to be 75 days, and the payment
behavior of the existing customers is not expected to change. Variable costs are 80% of sales. The firm’s opportunity
cost is 20%. Assuming a 360-day year, what is the company’s benefit (loss) on the planned change in credit terms?
C a. P 0 c. P 120,000
b. P 28,800 d. P 144,000
42. Based on a 360-day year, what is the current price of P 100 Treasury bill in 180 days on a 6% discount basis?
B a. P 100.00 c. P 94.00
b. P 97.00 d. P 93.00
43. The forms of short-term borrowing that are unsecured credit are
D a. Floating lien, revolving credit, chattel mortgage, and commercial paper
b. Factoring, chattel mortgage, bankers’ acceptances, and line of credit
c. Floating lien, chattel mortgage, bankers’ acceptances, and line of credit
d. Revolving credit, bankers’ acceptances, line of credit, and commercial paper
44. Sweden Co. considers to forego sales discounts in order to delay using its cash. Supplier credit terms are 2/10, n/30.
Assuming a 360-day year, what is the annual cost of credit if the cash discount is not taken and Sweden pays net 30?
D a. 24.0% c. 36.0%
b. 24.5% d. 36.7%
45. Norway buys on terms of 2/10, net/30, but generally does not pay until 40 days after the invoice date. Its purchases
total P 1,080,000 per year. How much non-free trade credit does the firm use each year?
B a. P 120,000 c. P 60,000
b. P 90,000 d. P 30,000
46. Finland plans to acquire an equipment costing P 2,400,000. A bank loan can finance the acquisition with a 10% discounted
interest. Alternatively, the company may delay payment to its suppliers. Presently, the company buys under terms of
2/10, net 40, but it believes payment could be delayed 30 additional days, without penalty (i.e., payment could be made
in 70 days). What should the company do?
A a. Borrow since it is cheaper by 1.13% than delaying payment to suppliers.
b. Borrow since it is cheaper by 2.5% than delaying payment to suppliers.
c. Delay payments to suppliers since it would cost 12% as against bank loan of 10%.
d. Delay payments to suppliers since it does not cost anything.
47. A compensating balance
A a. Compensates a financial institution for services rendered by providing it with fund deposits
b. Is used to compensate for possible losses on a marketable securities portfolio
c. Is a level of inventory held to compensate for variations in usage rate and lead time
d. Is the amount of prepaid interest on a loan
48. Romania Company’s bank requires a compensating balance of 20% on a P 100,000 loan. If the stated interest on the
loan is 7%, what is the effective cost of the loan?
D a. 5.83% c. 8.40%
b. 7.00% d. 8.75%
49. Belgium Company got a recent quote on a commercial bank loan of 16% discounted rate with a 20% compensating
balance. The term of the loan is one year. What is the effective cost of borrowing?
D a. 19.05% c. 22.85%
b. 20.00% d. 25.00%
50. A bank loans P 1,000,000 to Ireland for 180 days, with interest of P 60,000 to be paid. The bank also requires a P200,000
compensating balance for the loan period. What is the effective annual rate?
B a. 16.22% c. 14.00%
b. 15.00% d. 13.00%
51. Assume that a bank has lent a firm a P 200,000 for 60 days at 10% interest. The loan is discounted, and the bank
requires a 20% compensating balance. What is the effective annual rate?
B a. 14.60% c. 10.17%
b. 12.76% d. 10.00%
52. The Brunei Bank and Lugina Corp. signed a loan agreement subject to the following terms:
• Stated interest rate of 18% on one-year discounted loan
• 15% compensating non-interest-bearing checking account balance to be maintained by Lugina with Brunei Bank.
The net proceeds of the loan totaled P 1,000,000. What was the principal amount of the loan?
A a. P 1,492,537 c. P 1,176,471
b. P 1,219,512 d. P 1,000,000
53. Chile Co. obtained a short-term bank loan for P 250,000 at an annual interest of 6%. Under the loan, the company is
required to maintain a compensating balance of P 50,000 in its savings account that earns interest at an annual rate of
2%. The company would otherwise maintain only P 25,000 in the savings account for transaction purposes. What is
the effective interest rate of the loan?
B a. 5.80% c. 6.66%
b. 6.44% d. 7.00%
56. A company has accounts payable of P 5 million with terms of 2/15, n/30. It can borrow funds from a bank at an annual
rate of 12%, or it can wait until the 30th day when it will receive revenues to cover the payment. What is total cost if it
borrows funds on the last day of the discount period in order to obtain the discount?
C a. P 24,500 more c. P 75,500 less
b. P 51,000 less d. P 100,000 less
57. Brazil Co. can issue 3-month commercial paper with a face value of P 1,000,000 for P 980,000. The transaction costs
would be P 1,200. What would be the annualized percentage cost of financing?
D a. 2.17% c. 8.48%
b. 8.00% d. 8.66%

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58. A company enters into an agreement with a firm that will factor the company’s accounts receivable. The factor agrees
to buy the receivables, which average P 100,000 per month and have an average collection period of 30 days. The
factor will advance up to 80% of the face value of the receivables at an annual rate of 10% and charge a fee of 2% on
all receivables purchased. The company controller estimates that the company would save P 18,000 in collection
expenses over the year. Fees and interest are not deducted in advance. Based on a 360-day year, what is the annual
cost of financing?
D a. 10.0% c. 14.0%
b. 12.0% d. 17.5%
59. A firm often factors its accounts receivable. Its finance company requires a 6% reserve and charges a 1.4% commission
on the amount of the receivables. The remaining amount to be advanced is further reduced by an annual interest charge
of 15%. What proceeds will the firm receive from the finance company at the time a P 100,000 account due in 60 days
is factored?
B a. P 85,000 c. P 92,600
b. P 90,285 d. P 96,135
60. Greece, Inc. plans to factor its receivable and has collected data on the following finance companies:
Required reserves Commissions Annual interest charge
Company A 6% 1.4% 15%
Company B 7% 1.2% 12%
Company C 5% 1.7% 20%
Company D 8% 1.0% 5%
Which company will give Greece the highest proceeds from a P 100,000 account due in 60 days?
A a. Company A c. Company C
b. Company B d. Company D
61. The economic order quantity formula indicates that
D a. Annual quantity of inventory to be carried c. Safety stock plus estimated inventory for the year
b. Annual usage of materials during the year d. Quantity of each individual order during the year
62. The optimal level of inventory would be affected by all of the following, except the:
B a. Cost per unit of inventory
b. Current level of inventory
c. Usage rate of inventory per time period
d. Cost of placing an order for the merchandize
63. The following data refer to various annual costs relating to the inventory of a single-product company:
Unit freight on purchase P 0.20
Storage per unit P 0.12
Insurance per unit P 0.10
Annual interest foregone from alternate investment of funds P 8,000
Annual number of units required 100,000
What is the annual carrying cost per unit?
B a. P 0.22 c. P 0.42
b. P 0.30 d. P 0.50
Solution: 0.12 + 0.10 + (8,000/100,000) Note: The unit freight of P 0.20 is not considered as a carrying cost.
64. One of the elements included in the economic order quantity (EOQ) formula is
B a. Safety stock c. Selling price of the item
b. Yearly demand d. Lead time for the delivery
65. Melon Company sells 20,000 radios evenly throughout the year. The cost of carrying one unit in inventory for one year
is P 8, and the purchase order cost per order is P 32. What is the economic order quantity?
B a. 200 units c. 500 units
b. 400 units d. 600 units
66. Tamarind Company manufactures bookcases. Set up costs are P 2.00. Tamarind manufactures 4,000 bookcases evenly
throughout the year. Using the economic order quantity approach, what is the optimal production run would be 200
when the cost of carrying one bookcase in inventory for one year?
D a. P 0.05 c. P 0.20
b. P 0.10 d. P 0.40
67. Pomelo, Inc. has determined the following for a given year:
Economic order quantity (standard order size) 5,000 units
Total cost to place purchase orders for the year P 10,000
Cost of place one purchase order P 50
Cost carry one unit for one year P4
What is Pomelo’s estimated annual usage in units?
A a. 1,000,000 c. 4,000,000
b. 2,000,000 d. 2,250,000
68. Jackfruit Company has computed its EOQ as 500 units. However, management would rather order in quantities of 600
units. How will Jackfruit’s total purchase order cost and total annual carrying cost for an order quantity of 600 units
compared to the respective amounts for an EOQ of 500 units?
D a. Higher purchase order cost and higher carrying cost.
b. Lower purchase order cost and lower carrying cost.
c. Higher purchase order cost and lower carrying cost.
d. Lower purchase order cost and higher carrying cost.
69. Which of the following would tend to increase the holdings of inventory quantity in the future?
B a. Increased computer control c. Standardization of products
b. Increased rate of sales growth d. Limiter variety of products

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70. The amount of inventory that a company would tend to hold in stock would increase as the
B a. Variability of sales decreases
b. Cost of carrying inventory decreases
c. Cost of running out of stock decreases
d. Sales level fails to a permanently lower level
71. The following information relates to Pear Company’s raw materials:
Annual usage in units 7,200 Normal lead time in days 20
Working days per year 240 Maximum lead time in days 45
Assuming even demand for materials during the year, what is the (A) safety stock and (B) order point?
D a. (A) 600 (B) 750 c. (A) 750 (B) 600
b. (A) 600 (B) 1,350 d. (A) 750 (B) 1,350
72. The annual demand for a single product is 4,000 units. The cost to carry one unit is P 0.50 while cost per order amounts
to P 10.00. The average inventory being carried is computed for 225 units. How many units of safety stock are being
maintained?
A a. 25 units c. 200 units
b. 50 units d. None
Solution: Average inventory = (EOQ ÷ 2) + Safety stock → 225 units = (400 ÷ 2) + Safety Stock
73. A company has EOQ of 10,000 units and a safety stock of 2,000 units. The cost per unit of inventory is P 5.00 and the
carrying cost is 10% of the average value of inventory. What is the annual inventory carrying cost?
B a. P 3,000 c. P 5,000
b. P 3,500 d. P 6,000
74. Guyabano Company wishes to determine the amount of safety stock they should maintain for Product No. 333 to result
in the lowest cost. Each stock-out costs P 75 and the carrying costs of each unit of safety stock is P 1. Product No. 333
will be ordered five times a year.
Which of the following will produce the lowest cost?
C a. A safety stock of 10 units that is associated with a 40% probability of running out of stock
b. A safety stock of 20 units that is associated with a 20% probability of running out of stock
c. A safety stock of 40 units that is associated with a 10% probability of running out of stock
d. A safety stock of 80 units that is associated with a 5% probability of running out of stock
75. India operates a chain of hardware stores across Manila. The controller wants to determine the optimum safety stock
levels for an air purifier unit. The inventory manager compiled the following data:
 The annual carrying cost of inventory approximates 20% of the investment in inventory.
 The inventory investment per unit averages P 50.
 The stock-out cost is estimated to be P 5 per unit.
 The company orders inventory on the average of 10 times per year.
 The probabilities of a stock-out per order cycle with varying levels of safety stock are as follows:
Safety Stock Stock-out Probability
200 units 0 0%
100 units 100 units 15%
0 100 units 15%
0 200 units 12%
What is the total cost of safety stock on an annual basis with a safety stock level of 100 units?
B a. P 550 c. P 1,950
b. P 1,750 d. P 2,000

Solutions and clarifications to selected items

19. Square root of: 2 (2,000,000) 50 ÷ 0.08 = P 50,000 2M ÷ 50,000 = 40 transactions
Frequency of transactions: 360 days ÷ 40 transactions = every 9 days
24. 8% [(90,000,000/360)3] – 20,000 (4) = P 20,000 loss
26. Standard: 500(10%) + 12[10+0.1(80)] = P 266 Premium: 2,500(10%) = P 250
36. Age of AR: 60% (10) + 40% (30) = 18 days AR = 150 (300) x 18 = P 810,000
39. Old AR balance: 76.8M x (30/360) New AR balance: (76.8M x 1.3) x (45/360)
40. (27M ÷ 360) x 6 days x 8%
41. Benefit: 720,000 x 20% = P 144,000 Cost: (720,000/360) x 75 days x 80% x 20% = P 24,000
45. Non-free trade credit: (1,080,000 ÷ 360) x (40-10) = P 90,000
46. Loan: 10/90 = 11.1% Credit: 2/98 x 360/60 = 12.24%
50. 60,000 ÷ (1,000,000 - 200,000) = 7.5% 7.5% (360 ÷ 180) = 15%
Assuming interest is compounded, the effective annual rate (EAR) would have been:
(1 + 7.5%) 360/180 - 1 = 15.56%
NOTE: Unless indicated otherwise, interest is assumed to be non-compounded.
51. Interest = 200,000 x 10% x 60/360 = 3,333
[3,333 ÷ (200,000 – 40,000 – 3,333)] x 360/60 = 12.76%
52. (100% - 18% - 15%) Principal = P 1,000,000
53. [6% (250,000) – 2% (50,000 - 25,000)] ÷ [250,000 - (50,000 - 25,000)] = 6.44%
56. (5M x 98%) x 12% x 15/360 = P 24,500 vs. P 100,000 = 5M x 2 %
58. Interest: 80,000 x 10% x (30/360) = 666.7 Charges: 100,000 x 2% = 2,000
Cost of financing (factoring): {[666.7 + 2,000 - (18,000/12)] ÷ 80,000} x (360 ÷ 30)
59. Factoring proceeds: (100% - 6% - 1.4%) 100,000 – [92,600 (15%) X (60 ÷ 360)]
60. Using the same formula in No. 59, choice A yields the highest proceeds at P 90,285

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