FinMan SolMan

Chapter 1 Introduction to Financial Management
Answer Key
TRUE-FALSE STATEMENTS Black - true and Red - false.

1. Financial management is concerned with allocating, raising and controlling the funds of the firm.
2. The money market is created by a financial relationship between the suppliers and demanders of
short-term debt securities maturing in one year or less
3. The primary economic principle used in managerial finance is marginal cost–benefit analysis, the
principle that financial decisions should be made, and actions taken only when the added costs
exceed the added benefits.
4. Financial managers actively manage the financial affairs of many types of business—financial and
non-financial, private and public, for-profit and not-for-profit.
5. The issuance of commercial paper is in the area of investment decision.
6. Finance is concerned with the process institutions, markets, and instruments involved in the
transfer of money among and between individuals, businesses and government.
7. Managerial finance is concerned with design and delivery of advice and financial products to
individuals, business, and government.
8. The purchase of a new plant or properties for an expansion program is in the area of financing
decision.
9. The corporate controller is the officer responsible for the firm’s accounting activities, such as
corporate accounting, tax management, financial accounting, and cost accounting.
10. One advantage of forming a corporation is that you have limited liability.
11. Corporations face fewer regulations than sole proprietorships.
12. One disadvantage of being a sole proprietor is that you should pay corporate taxes, even though
you don’t realize the benefits of being a corporation.
13. Corporations generally face fewer regulations than sole proprietorships do.
14. Corporate shareholders have unlimited liability.
15. It is usually easier to transfer ownership in a corporation than it is to transfer ownership in a sole
proprietorship.
16. Stockholders are personally responsible for the liabilities of the corporation if it is unable to pay.
17. Normally, stockholders can only sell their ownership interests when the corporation is terminated.
18. Partners are personally responsible for the liabilities of the partnership if it is unable to pay.
19. Partners can normally transfer their partnership interests with ease.
20. A corporation is characterized by separate legal existence, transferability of ownership and limited
liability.
I. MULTIPLE CHOICE QUESTIONS Encircle the letter that corresponds to the best answer.
1. He or she is the one responsible in making investment, financial, and dividend policy-making
decisions of a firm.
a. stockholder
b. finance manager
c. employee
d. creditor
2. It is one of the objectives of financial management.

a. maximize earnings
b. maximize cash flows
c. maximize the size of the firm
d. maximize firm value/stock price
3. The choice to issue shares of stocks or long-term bonds falls under

a. investment decision
b. dividend decision
c. financing decision
d. none of the above
4. The issuance of commercial paper is in the area of

a. investment decision
b. dividend decision
c. financing decision
5. Which of the following is true about the finance managers as compared with the accountants?
a. They devote attention primarily to decision making through analysis of financial data.
b. They operate on an accrual basis, recognizing revenues at the point of sale and expenses when
incurred.
c. They focus on the actual inflows and outflows of cash, recognizing revenues when actually
received and expenses when actually paid.
d. All of the above
6. Which of the following is the best measure to ensure that management decisions are in the best
interest of the stockholders?
a. fire managers who are inefficient
b. remove management's perquisites
c. tie management compensation to the level of dividend per share
d. tie management compensation to the performance of the company's common stock price
7. In planning and managing the requirements of a firm, the financial manager is concerned with
________.
a. the mix and type of assets, but not the type of financing utilized
b. the type of financing utilized, but not the mix and type of assets
c. the mix and type of assets, the type of financing utilized, and analysis in order to monitor the
financial condition
d. the acquisition of fixed assets, allowing someone else to plan the level of current assets
required, and the market value of the share
8. Marginal analysis states that financial decisions should be made and actions should be taken only
when ________.
a. benefits equal costs
b. added benefits exceed added costs
c. added benefits are greater than zero
d. marginal revenue equals marginal cost
9. By concentrating on cash flows within a firm, the financial manager should be able to ________.
a. avoid insolvency
b. prepare tax returns
c. control the share price
d. maintain public relations
10. Finance is ________.

a. the art and science of managing money
b. the art of merchandising products and services
c. the system of verifying, analyzing, and recording business transactions
d. the science of the production, distribution, and consumption of goods and services
11. Which of the following is a duty of a financial manager in a business firm?

a. auditing financial records
b. raising financial resources
c. controlling the stock price
d. developing marketing plans
12. The primary goal of a financial manager is ________.

a. minimizing risk
b. maximizing profit
c. minimizing return
d. maximizing wealth
13. Corporate owners receive return ________.

a. through interest earnings and earnings per share
b. through capital appreciation and retained earnings
c. by realizing gains through increases in share price and cash dividends
d. by realizing gains through increases in share price and interest earnings
14. Which of the following is not a principle of basic financial management?

a. Profit is king
b. Risk/return tradeoff
c. Efficient capital markets
d. Incremental cash flow counts
15. It is concerned with allocating, raising and controlling the funds of the firm.
a. finance
b. management accounting
c. financial management
d. budgeting
16. This refers to two or more persons binding themselves to contribute money, property, or industry
to a common fund, with the intention of dividing profits between or among themselves
a. sole proprietorship
b. partnership
c. corporation
17. It is a weakness of a sole proprietorship

a. unlimited life
b. easy to form
c. limited liability
d. limited access to capital
18. Which of the following is not an essential characteristic of a corporation?

a. It is an artificial being
b. It is created by the operation of law
c. It enjoys the right of succession
d. It divides profits among the stockholders
19. Which of the following statements is an advantage of a sole proprietorship?

a. It cannot raise a large amount of capital.
b. It has unlimited liability.
c. The life of the business is dependent on the life of the owner.
d. It is easy to make a decision
20. A business partnership is formed for the purpose of _________________________

a. contributing money, industry, property
b. contributing money and property
c. contributing money
d. profit
Chapter 2 Financial Statements Analysis
Answer Key
TRUE OR FALSE
1 TRUE 11 TRUE 21 TRUE 31 FALSE
2 FALSE 12 FALSE 22 TRUE 32 FALSE
4 TRUE 14 FALSE 24 FALSE 34 FALSE
6 TRUE 16 TRUE 26 TRUE 36 TRUE
7 FALSE 17 TRUE 27 FALSE 37 TRUE
8 FALSE 18 FALSE 28 FALSE 38 TRUE
9 TRUE 19 FALSE 29 TRUE 39 FALSE
10 FALSE 20 TRUE 30 FALSE 40 FALSE
MULTIPLE CHOICE QUESTIONS

1 B 11 D 21 B 31 C
2 A 12 B 22 C 32 C
3 D 13 B 23 C 33 B
4 A 14 C 24 A 34 D
5 A 15 A 25 B 35 C
6 C 16 B 26 D 36 C
7 C 17 D 27 D 37 B
8 A 18 D 28 C 38 C
9 D 19 D 29 B 39 D
10 C 20 C 30 B 40 C
MULTIPLE CHOICE PROBLEMS

1 D (P26,000 - P24,000) / P24,000 = 0.0833
2 D (P20,000 / 1.15%) = 17,391.30
3 A (P770 / 700) = 1.10
4 C (P750,000 - P600,000) / P600,000 = 0.25
5 D Average daily sales / 365 days

P5,840,000 / 365 days = P16,000
Average A/R / Average daily sales
P800,000 / P16,000 = 50 days
6 B A/R TO = Net credit sales/ average AR

P5,840,000 / [(P780,000 + P820,000) / 2 ] = 7.30 times
7 C PES = MV per share / EPS = P50 / 5 = 10.00 times

EPS = P250,000 / 50,000 shares = P5 per share
8 C POR = Dividend per share / EPS = (P60,000 / 50,000 sh) / P5 0.20

9 C Number of times interest earned = EBIT / Interest expense
(P420,000 + P80,000 ) / P80,000 = 6.25
10 B AR TO = Net sales / Average AR = 10 = ( NS / P400,000) = 4,000,000.00
11 A number of days = AAI / Average daily sales

29.2 dats = P60,000 / ADS
Ave. daily sales = P60,000 /29.2 days == P2,054.79 x 365 days = 749,998.35
or P750,000
12 B Asset TO = Net sales / Ave Total Assets
3 = P1,500,000 / Ave. total assets
Average Total assets = P1,500,000 / 3 = P500,000
Ending Total assets = (P500,000 x 2) - P700,000 = 300,000.00
13 A CAR = (P40,000 + P25,000 + P P20,000 ) / P60,000 = 1.42
14 C AR TO = Net Sales / Ave. AR = P85,000 / P25,000 = 3.40
15 B Inventory TO = Cost of Sales / Ave Inventory =

I TO = P45,000 / P20,000 = 2.25
16 A ROA = Net income / Ave. investments = P20,000 / P295,000 = 0.068
17 C Profit Ratio = Net income / Net sales = P20,000 / P85,000 = 0.235
18 A ROE = Net income / SE = P20,000 / P150,000 = 0.133
19 A P E R = Market value per share / EPS = P20 / (P20,000 / 6,000 sh)

= P20 / 3.33 = 6.0
20 A Cash provided by operations / Average Current liabilities

P30,000 / P60,000 = 0.50
21 D Debt / Equity ratio = Total Liabilities / Total SE

DER = (P1,000 + P2,000) / (P4,000 + P5,000) = 0.33
22 B P1,475,000 AR TO = Net credit Sales / Ave. AR =

5 = NS / [(P250,000 + P300,000) / 2 ] =
Net sales = P275,000 x 5 = P1,375,000 + P100,000 1,475,000.00
23 D Inventory TO = P120,000 [(P25,000 + P35,000) / 2 ] = 4

Days in inventory = 360 days / 4 = 90
24 B Inventory TO = COS / AAI = P480,000 / P80,000 = 6
25 A EPS = NI / Shares outstanding = P10,000 / 2,000 shares 5.00
26 B EPS = P50,000 / 100,000 = 0.50
27 B NI + Expenses = Sales
ROE = NI / CSE = 12% = NI / P80,000 = P80,000 x 12% = 9,600.00
Net income, P9,6000 + Expenses, P43,000 = 52,600.00
28 C total assets = 80,000.00
stockholders equity = 60,000.00
total liabilities = 20,000.00
DER = P20,000 / P60,000 = 0.33
29 C ROA = NI before Interest , net of tax / ave. total assets

= P36,800 + [P4,000 x (1-.30)] / P400,000 =
= ( P36,800 + P2,800 ) / P400,000 = 0.099
30 D ROE = (NI - Dividend to PS ) / Common Stockholders' equity

= [P36,8000 - (P100,000 x 8%) ] / (P60,000 + P150,000 + P30,000)
= P28,800 / P240,000 = 0.12
31 B EPS = P28,800 / ( P60,000 / P20 par) = P28,800 / 3,000 sh = 9.60
32 D For the write-off no change; for the recognition of bad debts, WC decrease by P30,000
33 A 5 = NS / [(P500,000 + P600,000 ) / 2] = P550,000

P550,000 x 5 = P2,750,000 + P200,000 = 2,950,000.00
34 C P2,200,000 / [(P400,000 + P 600,000 *) / 2 ] = 4.4 times

CGS 2,200,000.00
Ending inventory 400,000.00
total available for sale 2,600,000.00
purchases (2,000,000.00)
*beginning inventory 600,000.00
35 A Sales P4,000,000 x 162.5% = 6,500,000.00

Costs ( M , L & others) = P400,000 + P1,500,000 5,500,000.00
Net income 1,000,000.00
Income tax at 35% 350,000.00
Net income after tax 650,000.00
ROS = P650,000 / P6,500,000 = 0.10
36 C ROA = P650,000 / P2,600,000 = 0.25
37 C A T O = Net sales / Total assets = P6,500,000 / P2,600,000 2.50
38 B Total assets - Total liabilities = Stockholders' equity

P2,600,000 - [(20% x P2,600,000)] = SE
P2,600,000 - P520,000 = P2,080,000
ROE = NI / SE = P 650,000 / P2,080,000 = 0.3125
39 C Sales = P120,000 / 10% = P1,200,000

AR balance = Sales / AR TO ; P1,200,000 / 8 = P150,000 150,000.00 #40
If AR is 60% of total current assets, TCA = P150,000 / .60 = P250,000
If cash is 8% of TCA, P250,000 x 8%, cash is P250,000 x 8% 20,000.00 #39
40 B
PROBLEMS
2.1 a AR TO = P20,300 / [ (P7,500 + P6,800) / 2] =

P20,300 / P7,150 = 2.84 times
b Inventory TO = P10,300 / [(P12,240 + P 8,700) / 2 ] =

P10,300 / P10,450 = 0.99 times
2.2 a Current assets Ratio

Accounts Receivable 75,000.00
Cash 125,000.00
Inventory 90,000.00
Short term inventory 60,000.00
Total current assets a 350,000.00
Current liabilities
Accounts Payable 74,000.00
Short term Payable 40,000.00
b 114,000.00
Current assets Ratio (a / b) P350,000 / P114,000 = 3.07
b Quick asset ratio P260,000 / P 114,000 = 2.28

Accounts Receivable 75,000.00
Cash 125,000.00
Short term inventory 60,000.00
Total current assets 260,000.00
c Debt to total asset ratio = Total Debts / Total assets

= P185,000 / P469,000 = 0.394
d Profit margin ratio = Net income / Net sales

= P 31,500 / P 240,000 = 0.1313
2.3 Change Percentage

Increase Change
2018 2017 (decrease) Inc (dec)
a Accounts Receivable 175,000.00 140,000.00 35,000.00 25.00%
b Retained Earnings 30,000.00 (40,000.00) 70,000.00 none
c Sales 855,000.00 750,000.00 105,000.00 14.00%
d Operating Expenses 170,000.00 200,000.00 (30,000.00) -15.00%
e Income taxes payable 22,000.00 20,000.00 2,000.00 10.00%
2.4 2019 2018 2017

Net sales 226,000.00 212,000.00 200,000.00
113 106 100
Cost of Sales 150,000.00 140,000.00 136,000.00
110 103 100
Gross Profit 76,000.00 72,000.00 64,000.00
trends are all favorable - increasing 119 113 100
2.5 1 Inventory turnove =
COS / Ave Inventory = P600,000 [(P130,000 + P P150,000) / 2 ] =
P600,000 / P140,000 = 4.3 times
2 Number of times interest earned ratio = EBIT / Interest expense

(P150,000 + P40,000 + P P60,000)] / P40,000
P250,000 / P40,000 = 6.25 times
3 Accounts Receivable Turnover = Net Sales / Ave. AR

P800,000 / [(P175,000 + P200,000 ) / 2 ] =
P800,000 / 187,500 = 4.3 times
4 Return on Assets ratio in 2008 = Net Income / Total assets =

P150,000 [(P1,100,000 + P 800,000) / 2 ] =
P150,000 / P950,000 = 15.79%
5 Current cash debt coverage ratio =

= Cash provided by operations / Average Current liabilities
P220,000 [(P140,000 + P110,000) / 2] = 1.76 times
2.6 a Current ratio = P270,000 / P170,000 = 1.588
b Current cash debt coverage ratio =

P120,000 / [(P170,000 + P155,000 ) /2 ] = 0.74 times
c Receivable turnover = Net Sales / Average AR

P475,000 [(P60,000 + P95,000 ) / 2 ] = P475,000 / P77,500 = 6.13 times
d Inventory Turnover = COS / Ave. inventory

P250,000 [(P110,000 + P 90,000 ) / 2] = P250,000 / P100,000 = 2.50 times
2.7 a Number of times bond interest earned =

= EBIT / Interest Expense = (P950,000 + P300,000) / (P5,000,000 x 6%)
1,250,000.0 / 30,000 4.17 times
b EPS of CS = Net income available to common stock / CS shares

= [P950,000 - P285,000 - (P1,000,000 x 6%)] / 200,000 shares
= (P665,000 - P60,000) / 200,000 shares = P 605,000 / 200,000 3.03 per share
c Price earnings ratio = Market value per share / EPS = P40 / P3.03 = 13.20
2.8 Y2017 = P 4,000,000

Y2018 = P4,000,000 x 60% = 2,400,000
Y2019 = ( P4,000,000 x 1.10%) + P4,000,000 = 8,400,000.00
2.9 Income Statement
Net sales 200,000.00
Cost of Sales 100,000.00
Gross Profit 100,000.00
Expenses:
Depreciation Expense 15,000.00 (5)
Interest Expense 5,000.00
Selling Expense 10,000.00
Administrative Expens 15,000.00
Total 45,000.00 (4)
Income before income tax 55,000.00 (2)
Tax expense 15,000.00 (3)
Net income 40,000.00 (1)
Solutions:
1 Net income = Sales x Profit ratio = P200,000 x 20% = 40,000.00
Let X = income before taxes

X = 12
P5,000 interest expense
X = P5,000 x 12 = 60,000.00
Earnings before interest and taxes (EBIT) 60,000.00

Less, interest expense 5,000.00
Net income before taxes 55,000.00 (2)
Net income after taxes 40,000.00
Income taxes 15,000.00 (3)
4 Total Expenses = P100,000 - P55,000 = P45,000
5 Depreciation expense = Total Expenses less other expenses

= P45,000 - (P5,000 + P10,000 + P15,000) = 15,000.00
items for balance sheet:

6 AR TO = Net sales / Ave AR = P200,000 / AAR = 5 x
= Ave AR = P P200,000 / 5 = P40,000
AR, end = P40,000 x 2 = P80,000 - P50,000 = 30,000.00
7 Accounts Payable using acid test ratio:

Acid test ratio = 1.4
Total Current liabilities = (P25,000 + P15,000 + P P30,000) = 1.4
Current liabilities
AP = P70,000 / 1.4 = P50,000 - P35,000 = 35,000.00
8 Inventory using CAR CAR = 2.5 x
Total Current liabilities = P50,000
Total Current assets = P50,000 x 2.5 = 125,000.00
Less, quick assets 70,000.00
Inventory 55,000.00
9 Total Assets = TCA + PPE = P125,000 + P200,000 = 325,000.00
11 Total assets = P325,000, therefore, Total Liabilities and SE = P325,000
10 TLE = P325,000 - (P35,000 + P15,000 + P200,000 + P47,000) = 28,000.00
2.10 a AR TO = NS / Ave AR = P5,200,000 / P700,000 = 7.43
b Average collection period = 365 days / AR TO = 365 / 7.43 = 49 days
c Inventory turnover = COS / Ave Inventory

Cost of sales = P5,200,000 x 80% = P4,160,000
Average inventory:
Beg Inventory 482,000.00
Purchases 4,146,000.00
Available for sale 4,628,000.00
Cost of sales 4,160,000.00
Ending inventory 468,000.00
Average inventory = (P482,000 + P468,000) / 2 = P475,000
Inventory TO = P4,160,000 / P475,000 = 8.758

d Average days in inventory = 365 days / 8.758 = 41.68 days
e ROE = NI / Ave. CSE = P420,000 / P3,500,000 = 12%
2.11
Total Current Current Effect on
Items Transactions assets Ratio Net Income
1 Issuance of additional common stock in cash increase + increase + none (ne)
2 Merchandise is sold for cash increase + increase + increase +
3 A fixed assets is sold less than its book value increase + increase + decrease -
4 Income tax due for the previous year is paid decrease - increase + none (ne)
5 A fixed assets is sold less than its book value increase + increase + decrease -
6 A fixed assets is sold more than its book value increase + increase + increase +
7 Merchandise is sold on credit increase + increase + increase +
8 Payment is made to trade accounts payable decrease - increase + none (ne)
9 A cash dividend is declared and paid decrease - decrease - none (ne)
10 Cash is obtained through short term loans increase + decrease - none (ne)
11 Short term notes receivable are sold at a discount decrease - decrease - decrease -
12 Marketable securities are sold below cost decrease - decrease - decrease -
13 Advances are made to employees none (ne) none (ne) none (ne)
14 Current operating expenses are paid decrease - decrease - decrease -
NOTES: In #2 and # 7 assumed regular sales were selling price is greater than its cost.
2.12
The company paid P2 in dividends and retained P2 per share. Since total retained earnings rose by P12 M,
there must be 6 million shares outstanding. With a book value of P40 per share, total common equity
must be P40 (6 million) = P240 million. Since the company has P120 million of debt, its debt ratio
must be 33.3 percent.
EPS = 4
Dividend per share = 2
Increase in Retained earnings 2 = P12,000,000
Debt/Assets = Debt / (debt + equity) = P120 M / (P120M + P240M) = 33.33%
2.13 SUPPORTING COMPUTATIONS TO THE BALANCE SHEET AND INCOME STATEMENT:
1 Net sales = Gross Profit / Gross profit ratio = P525,000 / 35% 1,500,000.00
2 Cost of sales = Net sales x cost of sates ratio P1,500,000 x 65% 975,000.00
3 Operating expenses = P1,500,000 x 15% 225,000.00
4 Operating income = P1,500,000-975,000-225000 300,000.00
5 Interest Expense = Operating income / times interest earned
P300,000 /6 times = 50,000.00
6 Bonds Payable = Interest expense / Interest Rate = 400,000.00

7 Receivable turnover = 360 days / age in receivables 360 days / 36 days 10 times
8 Average Receivable = Net credit sales / AR turnover P1,500,000 / 10 times 150,000.00
9 Ending Accounts Receivable = (Average AR x 2) - Beginning AR
(P150,000 x 2) - P160,000 140,000.00
10 Average inventory = Cost of goods sold / inventory turnover =

P975,000 / 4 times 243,750.00
11 Ending Inventory = (Average Inventory x 2) - Beginning inventory

(P243,750 x 2) - P250,000 237,500.00
12 Total debt = Ratio of total debt x stockholders' equity

.80 x P800,000 640,000.00
13 Current Liabilities = Total debt - Bonds payable = P640,000 -P400,000 240,000.00

14 Quick assets = Acid - test ratio x Current liabilfities = 1.3 x P240,000 312,000.00
15 Cash = Quick assets - Marketable securities - Accounts Receivable
P312,000 - P50,000 - P140,000 122,000.00
Libby Company
Balance Sheet
As of December 31, 2008
ASSETS
Current Assets:
Cash 122,000.00
Marketable Securities 50,000.00
Accounts Receivable, net 140,000.00
Inventories 237,500.00 549,500.00
Plant Assets
Plant and Equipment, net 890,500.00
TOTAL ASSETS 1,440,000.00
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities 240,000.00
Long Term Liabilities:
Bonds Payable, 12.5% 400,000.00
Total Liabilities 640,000.00
Stockholders' Equity:
Common Stock 500,000.00
Retained Earnings 300,000.00 800,000.00
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY 1,440,000.00
Libby Company
Income Statement
As of December 31, 2003
Net sales 1,500,000.00

Cost of Goods Sold (975,000.00)
Gross Profit on sales 525,000.00
Operating Expenses (225,000.00)
Net operating income 300,000.00
Other Expenses:
Interest Expense (50,000.00)
Net income before taxers 250,000.00
Income taxes, 35% (87,500.00)
Net income 162,500.00
2.14 MATCHING
P 1 price earnings ratio
P 2 return on assets ratio
L 3 receivables turnover ratio
P 4 earnings per share ratio
P 5 payout ratio
L 6 current cash debt coverage ratio
L 7 current ratio
S 8 debt to total assets ratio
S 9 free cash flow
L 10 inventory turnover ratio
2.15
Ratios Formula Computations COMPUTA RATIO INDUSTRY
TIONS RESULTS AVE. STDS. COMMENTS
LIQUIDITY
CURRENT ASSET Current Assets / Current Liab. P700/P300 2.33 2.5 X slightly low
RATIO
ACID TEST RATIO (CA - Inventories) / Current Liab. P400 / P300 1.33 1X good
ASSET MGT RATIO

INVENTORY TO Cost of sales / Average Invty. P2544 /P257.5 9.88 9X good
DAYS SALES IN
INVENTORY 360 days / INV TO 360 d / 9.88 36.44 36 DAYS good
ACCOUNTS Net sales / Average AR P3,000 /

RECEIVABLE TO P332.5 9.02 5X very good
DAYS SALES IN
ACCOUNTS REC 360 days / AR TO 360 / 9.02 39.91 36 DAYS good
FIXED ASSETS TO Net sales / net fixed assets P3T/P1.3T 2.31 3X low
TOTAL ASSETS TONet sales / Total assets P3T/P2T 1.50 1.8 X low
DEBTS MANAGEMENT
DET TO TOTAL
ASSETS Total Debt / Total assets P1.1T/P2T 0.55 0.40 high
TIMES INTEREST
IS EARNED EBIT / Interest charges P266/P66 4.03 6X low
FIXED CHARGE
COVERAGE EBIT + Lease Payments P294 3.13 5.5 X low
Interest Charges + Lease paymt P94
CASH FLOW
COVERAGE Cash inflows P394 2.79 3.2 X low
[Int. + Lease + (PS div/1-T) + P141
( Debt repaymt / 1-T)]
PROFITABILITY
PROFIT MARGIN Net income to CS / Sales P112/P3T 0.04 0.05 low
ON SALES
BASIC EARNING
POWER EBIT / Total assets P266/P2T 0.13 0.17 low
RETURN ON TOTAL
ASSETS (ROA) NI to CS / Total Assets P112/P2T 0.06 0.09 very low
RETURN ON COMMON
EQUITY (ROE) NI to CS / Common Equity P112/ P880 0.13 0.15 low
MARKET VALUE
PRICE/EARNINGSPrice Per share/
RATIO Earnings per share P26.5/P2.24 11.83 12.5 X slightly low
MARKET BOOK Market price per share / P26.50

RATIO book value per share P17.60 1.51 1.8 X slightly low
Chapter 3 Working Capital and Cash Management
Answer Key
I TRUE OR FALSE
1 TRUE 16 FALSE
2 FALSE 17 TRUE
3 TRUE 18 FALSE
4 FALSE 19 FALSE
5 TRUE 20 FALSE
6 FALSE 21 TRUE
7 TRUE 22 FALSE
8 FALSE 23 FALSE
9 FALSE 24 TRUE
10 FALSE 25 FALSE
11 FALSE 26 TRUE
12 TRUE 27 FALSE
13 TRUE 28 TRUE
14 TRUE 29 TRUE
15 TRUE 30 FALSE
II MULTIPLE CHOICES QUESTIONS

1 C 11 B 21 C 31 A
2 D 12 D 22 D 32 C
3 D 13 B 23 C 33 D
4 D 14 A 24 A 34 A
5 D 15 A 25 B 35 D
6 B 16 C 26 B
7 D 17 A 27 C
8 D 18 B 28 C
9 C 19 D 29 C
10 A 20 B 30 D
PROBLEMS:
3.1
1. WC = P250,000 – P125,250 = P124,750
2. Cash conversion cycle (CCC)

COGS = P720,000/1.6 = P450,000 = Purchases
ASP = 360/(P450,000/P100,000) = 80 days

ACP = 360/(P720,000/P60,000) = 30 days
APP = 360/(P450,000/P56,250) = 37 days
CCC = 80 + 30 – 37 = 73 days
3.2
1. Cash Conversion Cycle (CCC)
ASP = 360/(P16.8B/P2.1B) = 45 days

ACP = 360/(P18B/P2.4B) = 48 days
APP = 360/(P11.25B/P1.25B) = 40 days
CCC = 45 + 48 – 40 = 53 days
3.3
1. Cost of an aggressive strategy for seasonal funding
Cost of short-term financing = 0.065  P250,000 = P 16,250
Cost of long-term financing = 0.090  300,000 = 27,000
Total cost of aggressive strategy P43,250
2. Cost of conservative strategy for seasonal funding

Cost of long-term financing = 0.0900  1,100,000 = P99,000
– Earnings on surplus balances = 0.0500  550,000 = 27,500
Total cost of conservative strategy = P71,500

3.4
Amount of cash collection per day P3,000,000
Number of days freed on the collection x 1
Amount of cash free P3,000,000
Increase in compensating balance 700,000
Increase in cash flow P2,300,000
Rate of return x 7.00%
Incremental Income P 161,000
3.5
1. How much is the advantage or disadvantage of the lockbox system offered by China?
Amount of cash freed per day P 500,000
Multiply Number of days cash is freed 2
Amount of cash freed up P1,000,000
Multiply Rate of return 10.00%
Expected return (benefit) P 100,000
Less Cost of lockbox system 96,000
Net advantage of availing the lockbox system P 4,000
2. How much is the advantage or disadvantage of the lockbox system offered by Land?
Amount of cash freed up P 840,000
Net advantage of availing the lockbox system P 2,800
3. How much is the advantage or disadvantage of the lockbox system offered by Metro?
Amount of cash freed up P 700,000
Net advantage (disadvantage) of lockbox system ( P12,000)
3.6
Days
Inventory 60
Receivables 45
Operating Cycle 105
Payable (30)
Cash conversion cycle 75
3.7
Mail float 6
Processing float 3
Clearing float 2
Total float (present) 11
Float (using lockbox) 3
Savings 8
Average daily collections 150,000
Increase in average cash balance 1,200,000
3.8
Benefit - Interest income (P2*P100,000*6%) 12,000
Cost (P500*12mos) (6,000)
Net annual benefit (cost) 6,000
3.9
Savings - interest (2*P115,000*4%) 9,200
Cost (5,000)
3.10
Savings - interest (3*P100,000*5%) 15,000

Cost (P10,000-P5,000) (5,000)
3.11
Cost of short-term financing = 0.0700  P180,000 = P12,600
Total cost of aggressive strategy = P35,100

3.12
Cost of short-term financing = 0.0600  P120,000 = P 7,200
Total cost of aggressive strategy = P39,200

Aggressive strategy has P16,800 net advantage over the conservative strategy
3.13 a Current asset ratio P40,000/ P23,000 = 1.74 x
Net working capital P40,000 - P23,000 = 17,000
Return on total assets P6,000 / P60,000 = 10.00%
b Current asset ratio P40,000/ P11,000 = 3.64 x
Net working capital P40,000 - P11,000 = 29,000
Return on total assets P5,500 / P60,000 = 9.17%
c Yes From 1.74x ro 3.64x
d No From ROA of 10% it decreases to 9.17%
3.14 P = (2. days) x [(P500M)(.12)] / [(1M checks)(365 days)] =

(2 x P60,000,000 ) / 365,000,000 checks = 0.328767
3.15 .35 = (TF days) x [(P48M)(.12)] / [(60,000 checks)(365 days)]
TF = 1.33 days 1.33 days
3.16 (P30,000,000 / 365 days) (3) (0.11) =

82,191.78 x 3 x 11% = 27,123
3.17
ASP = 360/(P4,374,000/P72,900) = 6 days

ACP = 360/(P13,500,000*0.80/P1,200,000) = 40 days
APP = 360/(P19,200,000*0.60/384,000) = 12 days
1. Operating Cycle = 6 + 40 = 46 days

2. Cash Conversion Cycle = 6 + 40 – 12 = 34 days
3. The amount of resources needed to support the firm’s cash conversion cycle = P888,900
Inventory = P4,374,000 x (6/360) = P72,900

AR = P13,500,000 x 0.80 x (40/360) = P1,200,000
Less AP = P19,200,000 x 0.60 x (12/360) = P384,000
Resource Invested = P888,900
3.18
a. Optimal Transaction Size
2 × 12,500,000 × 4 ×30
MS =√
0.08
MS = P111,803.40
b. Average cash balance
MS/2 = P111,803.40/2 = P55,901.70
c. the number of times (during the year) the company has to convert marketable securities to cash
= P12,500,000 x 4 / P111,803.40
= 447.213 times or 448 times
d. the total cost of converting marketable securities to cash
= 447.213 times x 10 = P4,472.13, or

= 448 times x 10 = P4,480
e. the total carrying cost of cash
= (P111,803.40/2) x 0.08 = P4,472.14

Chapter 4 Receivable Management
Answer Key
I. TRUE OR FALSE STATEMENTS Black is true and Red is false.
1. Holding all other variables constant, as accounts receivable increases, the cash conversion cycle decreases.
2. Accounts receivable variables under control of the financial manager include level of credit sales, terms of
credit sales, and quality of credit customers.
3. If upon examination of a firm’s existing credit policy it is discovered that bad debt losses have increased
for certain credit groups, it does not follow that extension of credit to those groups should be withheld.
4. An aging of accounts receivable measures the amount of receivables that have been outstanding for given
lengths of time.
5. An increase in sales resulting from an increased cash discount for prompt payment would be expected to
cause an increase in the average collection period.
6. When a company analyzes credit applicants and increases the quality of the accounts rejected, the company
is attempting to maximize sales.
7. Other things held constant, the higher a firm’s days sales outstanding (DSO), the better its credit
department.
8. If a firm sells on terms of 2/10, net/30 and its DSO is 30 days, then the firm probably has some past due
accounts.
9. If a firm that sells on terms of net/30 changes its policy to 2/10, net/30, and if no change in sales volume
occurs, then the firm’s DSO will probably increase.
10. If a firm sells on terms of net/60 and its sales are highly seasonal, with a sharp peak in December, then its
DSO as it is typically calculated (with sales per day = sales for past 12 months/365) would probably be
lower in January than in July.
II. MULTIPLE CHOICE QUESTIONS

Encircle the letter that corresponds to the best answer of the following statements.
1. The primary objective in the management of accounts receivable is to

a. realize no bad debts because of the opportunity cost involved.
b. provide the treasurer of the corporation with sufficient cash to pay the company’s bills on time.
c. coordinate the activities of the manufacturing marketing and financing so that the corporation can
maximize its profits.
d. achieve that combination of sales volume, bad debt experience, and receivables turnover that
maximizes the profits of the corporation.
2. At any point in time, the level of the accounts receivable on a corporate statement of financial position is
least affected by which of the following factors?
a. tight money
b. credit standards of the seller
c. collection practices of the seller
d. length of the company’s production process
3. Ignoring cost and other effects on the firm, which of the following measures would tent to reduce the cash
conversion cycle?
a. Take discounts when offered.
b. Forgo discounts that are currently being taken.
c. Maintain the level of receivables as sales decrease.
d. Buy more raw materials to take advantage of price breaks.
4. An increase in a firm’s collection period means

a. The firm’s current ratio is increasing.
b. The firm’s collection expenses have fallen.
c. The firm’s receivables turnover ratio is increasing.
d. The firm has become less efficient in the collection of its receivables
5. Changing a firm’s credit terms from 2/10, n/60 to 2/10, n/30 will generally
a. reduce the average collection period and reduce sales.
b. increase the average collection period and reduce sales.
c. reduce the average collection period and increase sales.
d. increase the average collection period and increase sales.
6. The collection of accounts receivable can be accelerated by the use of

a. bank drafts.
b. a lockbox system.
c. remittance advices.
d. turnaround documents.
7. An increase in sales resulting from an increased cash discount for prompt payment would be expected to
cause a(an)
a. increase in the operating cycle.
b. decrease in the cash conversion cycle.
c. increase in the average collection period.
d. decrease in the purchase discounts taken.
8. Which of the following represents methods for converting accounts receivable to cash?
a. Factoring, pledging and electronic funds transfer.
b. Trade discounts, collection agencies and credit approval.
c. Cash discounts, electronic funds transfers and credit approval.
d. Cash discounts, collection agencies and electronic funds transfers.
9. An organization would usually offer credit terms of 2/10, n/30 when

a. the cost of capital approaches the prime rate.
b. the organization can borrow funds at a rate less than the annual interest cost.
c. the organization can borrow funds at a rate exceeding the annual interest cost.
d. most competitors are offering the same terms, and the organization has a shortage of cash.
10. A change in credit policy has caused an increase in sales, an increase in discounts taken, a decrease in the
investment in accounts receivable and a decrease in the number of doubtful accounts. Based upon this
information, the company’s
a. working capital has increased.
b. average collection period has decreased.
c. percentage discount offered has decreased.
d. accounts receivable turnover has decreased.
11. The average collection period for a firm measures the number of days
a. before a typical account becomes delinquent.
b. for a typical check to clear through the banking system.
c. after a typical credit sale is made until the firm receives payment.
d. beyond the end of the credit period before a typical customer payment is received.
12. Which of the following would warrant the least amount of consideration in credit and collection policy
decisions?
a. credit period
b. cash discount given
c. quantity discount given
d. quality of accounts accepted
13. It is the process administering sales credit, enforcing credit and collection policies, and maintaining an
appropriate level of accounts receivable.
a. receivable turnover
b. receivable management
c. working capital management
14. It indicates the number of times an average amount of receivables is collected during the period and the
efficiency of collection.
a. aging of receivables
b. average collection period
c. average accounts receivable
d. accounts receivable turnover
15. It is the average length of time required to convert a firm’s receivables into cash.
a. cash conversion cycle
b. receivables collection period
c. payables deferral period
d. days sales outstanding
III. MULTIPLE CHOICE PROBLEMS Encircle the letter that corresponds to the best answer.
1. Brew Ca has an average payment period of 30 days, an average age of inventory of 20 days, and a cash
conversion cycle of 30 days. What is Brew Ca’s average collection period?
a. 20 days
b. 40 days (30 + 30 – 20)
c. 80 days
d. None of the above
2. What is the effective annualized cost of foregoing the trade discount on terms 2/10 net 80 (round to the
nearest .1%)?
a. 9.0%
b. 10.5% (2/98 x 360/70)
c. 11.3%
d. 12.0%
3. What is the effective annualized cost of foregoing the trade discount with terms 2/15 net 70 (round to the
nearest .1%)?
a. 13.1%
b. 13.4% (2/98 x 360/55)
c. 14.3%
d. 14.7%
4. A company’s accounts receivable total ₱ 25,000 and the turnover rate is 15 times in one year. A turnover
rate of 10 times in one year is desired to increase sales by 20%. How much must be the increase or decrease
in the accounts receivable?
a. ₱45,000 increase
b. ₱45,000 decrease
c. ₱25,000 increase
d. None of the above
15 = Sales/P25,000
Sales = P375,000
New Sales – P375,000*1.20 = P450,000

New AR = P450,000/10 = P45,000
Increase in AR = P45,000 – P25,000 = P20,000 D
Use the following information to answer the next 5 questions:

Assume that your firm is considering relaxing its current credit policy. Currently the firm has annual
sales, all credit, of P16 million and an average collection period of 30 days. The firm is considering a change in
credit terms from the current terms of net 30 to 1/30 net 60. The change is expected to generate additional sales
of P2 million. The firm has variable costs of 75% of the selling price. The information provided here, plus
additional information, is summarized in the table below.
New sales (all credit) P18,000,000

Original sales (all credit) P16,000,000
Contribution margin 25%
Percent bad debt losses on new sales 6%
New average collection period 45 days
Original average collection period 30 days
Additional inventory investment P50,000
Pre-tax required rate of return 15%
New percent cash discount 1%
Percent of customers taking the discount 50%
5. If the credit policy change is made, the change in bad debt losses will be:
a. P180,000
b. P160,000
c. P120,000 [(P18,000,000 – P16,000,000) x 6%]
d. P90,000
6. If the credit policy change is made, the change in profit will be:
a. P200,000
b. P380,000 (P2,000,000 x 25% - 120,000)
c. P400,000
d. P550,000
7. If the credit policy change is made, the additional investment in accounts receivable will be:
a. P733,333
b. P850,000
c. P916,667 [(P18,000,000 x 45/360) – P16,000,000 x 30/360)]
d. P1,067,333
8. If the credit policy change is made, the cost of the additional investment in accounts receivable and
inventory will be:
a. P145,000 [(P916,667 + P50,000) x 15%]
b. P137,500
c. P128,000
d. P114,500
9. If the credit policy change is made, the change in the cost of the cash discount will be:
a. P80,000
b. P90,000 (P18,000,000 x 50% x 1%)
c. P100,000
d. P110,000
10. If the credit policy change is made, the net effect (i.e., incremental revenues versus incremental costs) will
be:
a. P375,000
b. P265,000
c. P145,000 (P500,000 – P120,000 – P145,000 – P90,000)
d. P 85,000
PROBLEMS
4.1
Stop and Chop has an inventory conversion period of 60 days, a receivable conversion period of 35
days, and a payment cycle of 26 days. Sales for the period just ended amounted to P972,000 while cost of sales
amounted to P1,260,000. Credit purchases amounted to P684,000. (Assume 360 days a year.)
Required:
1. How much is the investment in accounts receivable? P94,500 (P972,000 x 35/360)

2. How much is the cash conversion cycle? 69 days (60 + 35 – 26)
4.2
The Sales Director of Sweet Bites suggests that certain credit terms be modified. He estimates that sales
will increase by at least 20% and accounts receivable turnover will be reduced to 8 times from the present
turnover of 10 times. Bad debts, now at 1% of sales will increase to 1.5%. Sales before the proposed changes is
at P900,000. Variable cost ratio is 55% and desired rate of return is 20%. Fixed expenses amount to P150,000.
Required:
1. How much is the increase in profit from the sales? P81,000 (P900,000 x 20% x 45%)
2. How much is the cost of marginal investment in accounts receivable? P4,950
[(P1,080,000/8) – (P900,000/10)] x 55% x 20%
3. How much is the cost marginal bad debt? P7,200 [(P1,080,000 x 1.5%) – (P900,000 x 1%)]
4.3
Kisha Company has annual credit sales of P4 million. Its average collection period is 40 days and bad
debts are 5% of sales. The credit and collection manager is considering instituting a stricter collection policy,
whereby bad debts would be reduced to 2% of total sales, and the average collection period would fall to 30
days. However, sales would also fall by an estimated P500,000 annually. Variable costs are 60% of sales and
the cost of carrying receivables is 12%. (Assume 360 days a year)
Required:
1. How much is the decrease in profit from the sales? P200,000 (P500,000 x 40%)
2. How much is the savings from marginal investment in accounts receivable? P11,000
[(P4,000,000 x 40/360) – (P3,500,000 x 30/360)] x 60% x 12%
3. How much is the savings from marginal bad debt? P130,000 [(P4,000,000 x 5%) – (P3,500,000 x 2%)]
4.4
PhilArm, after computing the annualized cost of the credit terms is considering relaxing its credit
standards to encourage more sales. As a result, sales are expected to increase by 10% from the current 600 units
per year. The average collection period is expected to increase to 45 days from 30 days and bad debts are
expected to double the current 3% level. The selling price per unit is ₱1,500, the variable cost per canoe is ₱800.
The firm's required return on investment is 20%. (Assume a 300-day year)
Required:
1. How much is the firm's additional profit contribution from sales under the proposed relaxation of credit
standards? P42,000 [(P1,500 – P800) x (600 units x 10%)]
2. How much is the cost of marginal investments in accounts receivable under the proposed plan? P6,240
[(660 x 45/300) – (600 x 30/300)] x P800 x 20%
3. How much is the cost of marginal bad debts under the proposed plan? P32,400
[(P1,500 x 660 x 6%) – (P1,500 x 600 x 3%)]
Current: Proposed:
Credit Sales 600 units 690 units
Ave Collection Period 30 days 45 days
Bad Debts 3% of sales 6% of sales
Required rate of return: 20.00%
Sales ₱1,500
Less: Variable Cost 800
Contribution Margin ₱700
Incremental sales (660 - 600) 60 units
Additional profit contribution from
₱42,000
sales/incremental profit margin
Total Variable Cost: Proposed ₱ 800

Multiplied by: Proposed units x 660 units ₱528,000
Divided by: AR Turnover - Proposed 300 / 45 6.66
Average investment in AR under proposed plan ₱79,200
Less: Average investment in AR under present plan
Total Variable Cost: Present ₱ 800
Multiplied by: Present units x 600 units ₱480,000
Divided by: Present AR Turnover 300 / 30 10 48,000
Marginal investment in accounts receivable ₱31,200
Multiplied by: Required return on investment x 20%
Cost of marginal investment in accounts receivable ₱6,240
Bad Debts under proposed plan 6% x ₱1,500 / unit x 660 units = ₱59,400
Bad Debts under present plan = 3% x ₱1,500 / unit x 600 units = 27,000
Cost of marginal bad debts ₱32,400
Additional profit ₱42,000

Less: Cost of marginal investment in AR 6,240
Less: Cost of marginal investment in Bad Debts 32,400
Net effect on profits ₱3,360
4.5
Chopstop company plans to tighten its credit policy. The projected sales for the coming year are P50M.
The new policy will decrease the average number of days in collection from 75 to 50 days and reduce the ratio
of credit sales to total revenue from 70% to 60%. The company estimates that the projected sales would be 5%
less if the proposed new credit policy were implemented. The firm’s short-term interest cost is 10%. (assume a
360-day year)
Required:
1. How much is the average accounts receivable for the coming year using the present/current credit
policy?
2. How much is the average accounts receivable for the coming year using the proposed change in credit
policy?
3. How much would be the benefit (cost) of implementing this new policy on income before taxes?
Present/Current (P50M*70%*75/360) 7,291,667
Proposed (P50M*95%*60%*50/360) 3,958,333
Savings (P3,333,333*10%) 333,333
Cost - lost sales (P50M*5%) (2,500,000)
Net annual benefit (cost) (2,166,667)
4.6
GGEM offers branded designer prescription eyeglasses. All sales are currently on credit and with no
cash discount. The firm is considering a 2% cash discount for payment within 10 days. The firm's current
average collection period is 90 days, sales are 700 units per year, selling price is ₱25,000 per unit, variable cost
per unit is ₱18,750, and the average cost per unit is ₱21,000. The firm expects that the change in credit terms will
result in a minor increase in sales of 15 units per year, that 75% of the sales will take the discount, and the
average collection period will drop to 72 days. The firm's bad debt expense is expected to become negligible
under the proposed plan. The bad debt expense is currently 0.025% of sales. The firm's required return on equal-
risk investments is 20%. (Assume a 360-day year)
Required:
1. How much is the cost of the marginal cash discount?

2. How much is the net benefit (cost) of increasing the cash discount?
Unit sales expected from proposed plan 715

Expected percentage of sales that will avail of discount x 75%
Selling Price x ₱25,000
Proposed cash discount x 2%
Cost of cash discount ₱268,125
Incremental unit sales under the proposed plan 15 x 6,250 Units ₱93,750
Add: Cost savings from reduced investment in AR [(P2,681,250-3,281,250)*20%) 120,000
Add: Cost savings from marginal bad debts (700*P25,000*0,025%) 4,375
Less: Cost of cash discount 268,125
Net benefit (cost) of initiating a cash discount ₱(50,000)
4.7
DBA Company is considering changing its credit terms from 2/15, net 30 to 3/10, net 30 in order to
speed collections. At present, 40% of Sonata Company‘s customers take the 2% discount. Under the new term,
discount customers are expected to rise to 50%. Regardless of the credit terms, half of the customers who do
not take the discount are expected to pay on time, whereas the remainder will pay 10 days late. The change
does not involve a relaxation of credit standards; therefore bad debt losses are not expected to rise above their
present 2% level. However, the more generous cash discount terms are expected to increase sales from P2
million to P2.6 million per year. DBA’s variable cost ratio is 75%, the interest rate on funds invested in accounts
receivable is 9 %, and the firm’s income tax rate is 40%.
Required:
1. What is the days sales outstanding (DSO) before the change of credit policy? 27 days
2. What is the days sales outstanding (DSO) after the change of credit policy? 22.5 days
3. How much is the incremental after tax profit from the change in credit terms? P68,493.75
(150,000-843.75-12,000-23,000)*60%
4.8
Werpa Inc, after computing the annualized cost of the credit terms is considering relaxing its credit
standards to encourage more sales. As a result, sales are expected to increase by 15 percent from the current 600
units per year. The average collection period is expected to increase to 40 days from 30 days and bad debts are
expected to double the current 3 percent level. The selling price per unit is ₱1,550, the variable cost per canoe is
₱750 and the average cost per unit at the 600 unit level is ₱900. The firm's required return on investment is 20
percent. (Assume a 300-day year; for intermediate computations, use 2 d.p.)
Required:
1. What is the firm's additional profit contribution from sales under the proposed relaxation of credit
standards?
2. What is the cost of marginal investments in accounts receivable under the proposed plan?
3. What is the cost of marginal bad debts under the proposed plan?
4. What is the net result of implementing the proposed plan?
4.9
Lodi Optical, Inc, offers branded designer prescription eyeglasses. All sales are currently on credit
and with no cash discount. The firm is considering a 2 percent cash discount for payment within 10 days. The
firm's current average collection period is 90 days, sales are 700 units per year, selling price is ₱25,000 per unit,
variable cost per unit is ₱18,750, and the average cost per unit is ₱21,000. The firm expects that the change in
credit terms will result in a minor increase in sales of 15 units per year, that 75 percent of the sales will take the
discount, and the average collection period will drop to 72 days. The firm's bad debt expense is expected to
become negligible under the proposed plan. The bad debt expense is currently 0.025 percent of sales. The firm's
required return on equal-risk investments is 20 percent. (Assume a 360-day year.)
Required:
1. What is the marginal investment in accounts receivable under the proposed plan?
2. What is the cost of marginal investment in accounts receivable under the proposed plan?
3. What are the savings of marginal bad debts under the proposed plan?
4. What is the cost of the marginal cash discount?
5. What is the net result of increasing the cash discount?
Chapter 5 Inventory Management
Answer Key
I. TRUE OR FALSE STATEMENTS Black - True; Red - False
1. The financial manager’s general disposition toward inventory levels is to keep them low, to ensure that
the firm’s money is not being unwisely invested in excess resources.
2. The Economic Order Quantity (EOQ) Model is an inventory management technique for determining an
item’s optimal order size
3. Ordering costs are the variable costs per unit of holding an item in inventory for a specific period.
4. The safety stock is the point at which to reorder inventory, expressed as days of lead time  daily usage.
5. As the inventory turnover ratio increases, the inventory conversion cycle increases.
6. Firms should hold the maximum amounts of inventories that will ensure productions schedules or the
satisfaction of customer expectations.
7. The reorder point is an inventory management system that compares production needs to available
inventory balances and determines when orders should be placed for various items on a firm's bill of
materials.
8. Safety stock is used as a buffer against unexpected increases in demand, uncertainty about lead time, and
unavailability of stock from suppliers.
9. Enterprise resource planning (ERP) is an inventory management technique that minimizes inventory
investment by having materials arrive at exactly the time they are needed for production.
10. A materials requirement planning (MRP) system is an inventory management technique that applies EOQ
concepts and a computer to compare production needs to available inventory balances and determine
when orders should be placed for various items on a product’s bill of materials.
11. A purchasing manager would purchase higher inventories when prices are low and lower inventories
when prices are high irrespective of inventory requirement.
12. A marketing manager would like to have smaller inventories of finished products to ensure production of
goods as per customer specification.
13. A financial manager would keep inventory levels low to ensure that the firm's money is not unwisely
invested in excess resources
14. A manufacturing manager would keep raw materials inventories low to ensure use of latest materials in
production process.
15. Because its objective is to maximize inventory investment, a JIT system uses no (or very little) safety stock.
16. In a JIT system, extensive coordination among the firm’s employees, its suppliers, and shipping companies
must exist to ensure that material inputs arrive on time.
17. The costs of goods acquired from suppliers including incoming freight or transportation costs are called
purchasing costs.
18. Firms should hold the maximum amounts of inventories that will ensure productions schedules or the
satisfaction of customer expectations.
19. The economic-order-quantity decision model takes into account occurrence of stockouts.
20. As the inventory turnover ratio increases, the inventory conversion cycle increases.
21. In EOQ model, the average inventory is defined as the order quantity divided by 2.
22. In the EOQ model, the total cost is minimized at the point where the order costs and carrying costs are
equal.
23. The reorder point is an inventory management system that compares production needs to available
inventory balances and determines when orders should be placed for various items on a firm's bill of
materials.
24. Safety stock is used as a buffer against unexpected increases in demand, uncertainty about lead time, and
unavailability of stock from suppliers.
25. The objective for managing inventory is to improve the average collection period without affecting the
sales
II. MULTIPLE CHOICE QUESTIONS Encircle the letter that corresponds to the best answer
1. Assuming demand is deterministic, what is the essence of the economic order quantity model for
inventory?
a. To minimize order costs or carrying costs and maximize the rate of inventory turnover.
b. The minimize order costs or carrying costs, whichever is higher.
c. To order sufficient quantity to economically meet the next period's demand.
d. To minimize the total order costs and carrying costs.
2. Which of the following is a relevant factor in the determination of an economic order quantity?
a. Physical plant insurance costs.
b. Warehouse supervisory salaries.
c. Variable costs of processing a purchase order.
d. Physical plant depreciation charges.
3. The estimates necessary to compute the economic order quantity are

a. Annual usage in units, cost per order, and annual cost of carrying one unit in stock.
b. Annual usage in units, cost per unit of inventory, and annual cost of carrying one unit in stock.
c. Annual cost of placing orders, and annual cost of carrying one unit in stock.
d. Cost of placing orders and carrying cost.
4. What effect, if any, will a last-in, first-out inventory method have on economic order quantity (EOQ)?
a. No effect
b. LIFO will reduce the order quantity in times of rising prices.
c. LIFO will increase the order quantity in times of rising prices.
d. FIFO will increase the order quantity in times of rising prices.
5. A company buys a certain part for its manufacturing process. In order to determine the optimum size of a
normal purchase order, the formula for the economic order quantity (EOQ) is used. In addition to the
annual demand, what other information is necessary to complete the formula?
a. Cost of placing an order, and annual cost of carrying a unit in stock.
b. Cost of the part, and annual cost of carrying a unit in stock.
c. Cost of placing an order.
d. Cost of the part.
6. For inventory management, ignoring safety stocks, which of the following is a valid computation of the
reorder point?
a. The economic order quantity.
b. The economic order quantity multiplied by the anticipated demand during the lead-time.
c. The anticipated demand during the lead-time.
d. The square root of the anticipated demand during the lead-time.
7. Which of the following could be determined by using the economic order quantity formula?
a. Optimum size of a production run
b. Safety-stock
c. Stock-out cost
d. Order point
8. The order size determined by the economic order quantity formula minimizes the annual inventory cost
which is comprised of ordering costs and
a. Safety-stock cost
b. Stock-out cost
c. Set-up cost
d. Carrying cost
9. For its economic order quantity (EOQ) model, a company has a cost of placing an order equal to P10, and
an annual cost of carrying one unit in stock equal to P2. If the cost of placing an order increases by 20%
and the annual cost of carrying one unit in stock increases by 25% and all other considerations remain
constant, the EOQ will
a. Remain unchanged
b. Increase
c. Decrease
d. Either increase or decrease depending on the reorder point.
10. Uncertainty regarding product demand and delivery time for replenishing stock affects the size of a safety
stock inventory. In this regard, which of the following statements are correct?
i. The more certain is the delivery time for replenishing stock, the more safety stock is needed.
ii. The less certain is the delivery time for replenishing stock, the more safety stock is needed.
iii. The more certain is product demand, the more safety stock is needed.
iv. The less certain is product demand, the more safety stock is needed.
a. i and iii
b. i and iv
c. ii and iii
d. ii and iv
11. With regard to the optimal order quantity (Q*), which of the following statements are correct?
i. As carrying cost per unit increases, Q* increases.
ii. As total demand over the planning period increases, Q* increases.
iii. As ordering cost per unit increases, Q* increases.
a. i only
b. ii and iii
c. ii only
d. i, ii, and iii
12. The ________ is the time period that elapses from the point when a firm uses the raw materials in
manufacturing a finished good to the point when the finished good is sold.
a. cash turnover
b. cash conversion cycle
c. average age of inventory
d. average collection period
13. A firm may have a negative cash conversion cycle if it carries ________.
a. high inventory and sells its products for cash
b. high inventory and sells its products on credit
c. very little inventory and sells its products for cash
d. very little inventory and sells its products on credit
14. Jae Co. uses the economic order quantity (EOQ) model for inventory management. A decrease in which
one of the following variables would increase the EOQ?
a. Annual sales.
b. Cost per order.
c. Safety stock level.
d. Carrying costs.
15. The level of safety stock in inventory management depends on all of the following except the
a. Cost to reorder stock.
b. Cost of running out of inventory.
c. Level of uncertainty of the sales forecast.
d. Level of customer dissatisfaction for back orders.
16. The objective for managing inventory is to ________.

a. improve the average collection period without affecting the sales
b. turn over inventory as quickly as possible without losing sales from stockouts
c. make payment for the inventory as slowly as possible without losing suppliers
d. reduce the time taken to process inventory into finished goods and increase sales
17. ABC Company has correctly computed its economic order quantity at 1,000 units; however, management
feels it would rather order in quantities of 1,500 units. How should ABC’s total annual purchase order cost
and total annual carrying cost for an order quantity of 1,500 units compare to the respective amounts for
an order quantity of 1,000 units?
a. Lower purchase order cost and lower carrying cost
b. Lower purchase order cost and higher carrying cost
c. Higher purchase order cost and higher carrying cost
d. Higher purchase order cost and lower carrying costs
18. ABC Company has correctly computed its economic order quantity at 500 units; however, management
feels it would rather order in quantities of 450 units. How should ABC’s total annual purchase order cost
and total annual carrying cost for an order quantity of 450 units compare to the respective amounts for an
order quantity of 500 units?
a. Lower purchase order cost and lower carrying cost
b. Lower purchase order cost and higher carrying cost
c. Higher purchase order cost and higher carrying cost
d. Higher purchase order cost and lower carrying costs
19. The amount of inventory that a company would tend to hold in stock would increase as the
a. variability of sales decreases.
b. cost of carrying inventory decreases
c. cost of running out of stock decreases
d. sales level falls to a permanent lower level
20. To evaluate the efficiency of purchase transactions, management decides to calculate the economic order
quantity for a sample of the company’s products. To calculate the economic order quantity, management
would need data for all of the following, except
a. the volume of production sales.
b. the purchase prices of the products.
c. the fixed cost of ordering products.
d. the volume of products in inventory.
III. MULTIPLE CHOICE PROBLEMS Encircle the letter that corresponds to the best answer.
1. Sterling Clips, Inc. estimates that it will sell 10,000 porcelain clips next year. Because porcelain clips are so
easily damaged, the average per-unit carrying cost of the clips is P10. The per-order cost of ordering is P250.
Assume that Sterling wants a safety stock of 200 clips. If Sterling reorders the clips based on the economic
order quantity, what is Sterling’s average inventory of porcelain clips (round to the nearest 10 clips)?
a. 350
b. 450
c. 550
d. 650
2. One Shade Company will use an estimated 50,000 units in its manufacturing process next year. The
carrying cost of inventory is P.04 per unit, and the cost of reordering is P50 per order. What is the company’s
economic ordering quantity (round to the nearest 100 units)?
a. 11,200
b. 10,700
c. 9,700
d. 8,100
3. Auto Builders Corporation uses semi-hex joints in its manufacturing process. If the company’s total
demand for the joints for next year is estimated to be 15,000 units, and if the cost per order is P80, what is
the company’s economic order quantity? Assume that carrying costs for semi-hex joints are P.51 per unit
and round off to the nearest 100 units.
a. 1,600
b. 1,800
c. 2,000
d. 2,200
4. Wheels Company will use an estimated 4,000-wheel assemblies in its manufacturing process next year. The
carrying cost of the wheel assembly inventory is P0.60 per wheel, and the ordering cost per order is P20.
What is the economic ordering quantity of wheel assemblies (round to the nearest unit)?
1. 215
2. 365
3. 417
4. 516
5. Carter Company buys raw materials for its manufacturing process for P20 a part. Ten thousand parts a
year are needed. It costs P8 a year to carry one of these parts in inventory. The cost of placing a purchase
order for these parts is P10. Assuming that the parts will be required evenly throughout the year, the
formula for the economic order quantity is
a. 2 x 10,000 x 8
10
b. 2 x 10,000 x 10
8
c. 10,000 x 8
10
d. 10,000 x 10
8
6. The Aaron Company requires 40,000 units of Product Q for the year. The units will be required evenly
throughout the year. It costs P60 to place an order. It costs P10 to carry a unit in inventory for the year.
What is the economic order quantity?
a. 400
b. 600
c. 693
d. 490
7. Politan Company manufactures bookcases. Setup costs are P2. Politan manufactures 4,000 bookcases
evenly throughout the year. Using the economic order quantity approach, the optimal production run
would be 200 when the cost of carrying one bookcase in inventory for one year is
a. P0.05
b. P0.10
c. P0.20
d. P0.40
8. Garmar, Inc. has determined the following for a given year:

EOQ(standard order size) 5,000 units
Total cost to place purchase orders for the year P10,000
Cost to place one purchase order P50
Cost to carry one unit for one year P4
What is Garmar's estimated annual usage in units?

a. 1,000,000
b. 2,000,000
c. 4,000,000
d. 3,000,000
9. Barter Corporation had been buying Product A in lots of 1,200 units which represents a four month's
supply. The cost per unit is P100; the order cost is P200 per order; and the annual inventory carrying cost
for one unit is P25. Assume that the units will be required evenly throughout the year. What is the
economic order quantity?
a. 144
b. 240
c. 600
d. 1,200
For the next 3 items:
Neggie Corp has a secret ingredient in its production. This ingredient costs the company P60 each from the
supplier and requires a 6-day lead time. The demand every quarter is 13,680 units. The ordering cost is P12.50 per
order. (EOQ is 1200 units)
10. The carrying cost per unit is

a. P0.24
b. P0.95
c. P0.71
d. P0.48
11. The desired safety stock if the maximum daily usage is 175 units is
a. 138 units
b. 822 units
c. 912 units
d. 1,050 units
12. The total inventory cost amounts to
a. P288
b. P426
c. P576
d. P1,140
13. The General Chemical Company uses 150,000 gallons of hydrochloric acid per month. The cost of carrying
the chemical in inventory is 50 cents per gallon per year, and the cost of ordering the chemical is P150 per
order. The firm uses the chemical at a constant rate throughout the year. The chemical’s economic order
quantity is
a. 32,863 gallons
b. 11,619 gallons
c. 9,487 gallons
d. 1,900 gallons
order. The firm uses the chemical at a constant rate throughout the year. It takes 18 days to receive an order
once it is placed. The reorder point is
a. 7,500 gallons
b. 25,000 gallons
c. 90,000 gallons
d. 105,000 gallons
order. The firm uses the chemical at a constant rate throughout the year. It takes 18 days to receive an order
once it is placed. If the maximum usage is 162,000 gallons per month, the safety stock is
a. 625 gallons
b. 7,200 gallons
c. 8,125 gallons
d. 97,200 gallons
PROBLEMS
5.1
The ReignLyn Tags Company produces a luggage and bag tag product, and has the following information
available concerning its inventory items:
Annual demand - 50,000 units per year

Purchase price - ₱35 per package
Ordering costs - ₱250 per purchase order
Carrying costs - 10% of purchase price plus: ₱4.50
Required:
1. What is the economic order quantity? (round-off final answer in whole units)
2. What are the total relevant costs at the economic order quantity? (use EOQ rounded-off to 5 d.p.; total relevant
costs round-off to 2 decimal places)
3. What are the total relevant costs, assuming the quantity ordered equals 1,000 units?
Answers:
2D0 2 (50,000) 250
1. EOQ = √ EOQ = √10% X (35)+ 4.5
C
EOQ = 1,768 units
2.
Ordering Costs = O x S / EOQ
Ordering Costs = ₱250 x 50,000 = ₱7,071.07
1,767.76695
Carrying Costs = C x EOQ / 2
Carrying Costs = ₱8 x 1,767.76695 = ₱7,071.07
2
Total Relevant Costs ₱14,142.14
3.
Ordering Costs = O x S / OQ
Ordering Costs = ₱250 x 50,000 = ₱12,500.00
1,000
Carrying Costs = C x OQ / 2
Carrying Costs = ₱8 x 1,000 = ₱4,000.00
2
Total Relevant Costs ₱16,500.00
5.2
ABC Company sells 20,000 units of radio evenly throughout the year. The cost of carrying one unit in
inventory for one year is P8, and the purchase order cost per order is P32.
Required:
1. What is the company’s economic order quantity (EOQ)? 400 units

2. How much is the total ordering and carrying cost using the EOQ? P3,200
3. How much is the total ordering and carrying cost if the company’s order size is at 500 units? P3,280
5.3
XYZ Co. has determined the following for the coming period:
Total ordering and carrying cost using the standard order size (EOQ) P80,000
Cost to carry one unit P16
Cost to place one purchase order P100
Required:
1. What is the entity’s economic order quantity (EOQ)? 5,000 units

2. What is the entity’s estimated annual usage in units? 2,000,000 units
5.4
Yana Corp’s monthly material requirement used in production is 4,050 units. This material costs P180 per
unit for a supplier and it requires 5 days lead time from the date of order to date of delivery. The ordering cost is
P120 per order and the carrying cost is 8% of inventory investment per unit. (Use 360 days).
Determine the following:
1. EOQ 900 units

2. Frequency of order 6.67 days
3. Total inventory cost P12,960
4. Reorder point 675 units
5. Reorder point if maximum daily usage is 150 units 750 units
6. Safety stock 75 units
5.5
RCR Company has a secret ingredient in its production. This ingredient costs the company P60 each from
the supplier and requires 5-day lead time. The ordering cost is P25 per order and the carrying cost per unit is 10%
of purchase price. (EOQ is 2,400 units). Use 360 days
Determine the following:
1. Annual demand 691,200 units

2. Frequency of order 1.25 days
3. Total inventory cost P14,400
4. Reorder point 9,600 units
5. Reorder point if maximum daily usage is 1,200 units (maximum daily usage is 2,000 units instead of 1,200
units) Answer is 10,000 units
6. Safety stock 400 units
5.6
In its 2017 annual report, Racquel Corporation reported that it had revenues of P19.2 billion, cost of goods
sold of P16.8 billion, accounts receivable of P2.4 billion, inventory of P2.1 billion and accounts payable of P1.25
billion. Total purchases for the year was P11.25 billion. Use 360 days
Required:
1. What is the average age of inventory? 45 days
2. What is the amount of resources invested in inventory? P2.1 billion
3. Determine the cash conversion cycle. 50 days
5.7 NONE
5.8 1 Average inventory = Order size / 2
using EOQ as the order size 200 boxes / 2 = 100
the question was the average held during the year, so, 200 x 50 times of order = 5,000 boxes
2 EOQ = 2 x annual demand x ordering costs

Carrying costs
EOQ = 2 X 10,000 X P10 = 200.00 boxes

P5.00
3 Number of orders = Demand / order size
10,000 boxes / 200 boxes = 50 times
5.9
1 EOQ = 2 X 50 X P15 = 17 sets
15.00
2 lead time is one week 50 weeks in a year, 1 unit per week

Order point = daily demand x lead time + safety stock
OP = 1 unit per week x 2 weeks + 1 week safety stock =
= 2 +1 = 3 sets
5.10
1 EOQ = 2 X 500,000 X P1,000 = 47,673 lbs
20% x P2.20
2 Number of orders 500,000 / 47,673 = 10.488 orders
3 Average inventory (47,673 / 2 ) + 20,000 = 43,836
4 Reorder point = Average daily sales x lead time + safety stock =

(500,000 / 365) x 10 days + 20,000 = 33,699
5 Total inventory costs (total carrying and ordering costs) = Total Carrying costs + Ordering costs
Carrying costs = Average inventory x carrying costs per unit
Ordering costs = number of orders x cost per order
[43,836 x (20% x P2.20) ] + (10 x P1,000) =
P19,287.84 + P10,000 = 29,288
5.11
1 EOQ = 2 X 2,000 X P8 = 462
0.15
2 Ordering costs if once a year = P8

3 Ordering costs if four times a year = 4 x P8 = 32
5.12
1 EOQ = 2 X 2,000 X P10 = 200
1.00
2 Number of orders 10
3 Reorder point 40 units
5.13
Carrying costs
EOQ = 2 X 2,600,000 X P5,000 = 509,902.00 kilos

P5.00 x .02
since the order is multiples of 2,000, the company must order 510,000 kilos
2 average weekly sales = 2,600,000 / 52 weeks = 50,000.00 kilos

reorder point = 6 week's sales + safety stock
6 x 50,000 + 200,000 500,000.00 kilos
3 total inventory costs and carrying cost of safety stock:

TIC = [(2%) X(P5) X (510,000/2)] + (P5,000) X (2,600,000/510,000) +(.02) X (P5)(200,000)
= 25,500.00 + 25,500.00 + 20,000.00
= 71,000.00
4 Ordering costs would be reduced by P3,500 to P1,500. By ordering 650,000 kilos at a time,
the firm can braing its total inventory cost to P58,500
= (.02)(P5) (650,000/2) + (P1,500)(2,600,000/650,000)+(.02)(P5)(200,000)
= 32,500.00 6,000.00 20,000.00
= 58,500.00
Because the firm can reduce its total inventory costs by ordering 650,000 kilos at a time, it
should accept the offer and place large orders.
5.14
Carrying costs
EOQ = 2 X 36,000 X P100 = P7,200 / 24 548 dozens

P24.00
2 Inventory costs = Ordering costs + carrying costs

36,000 / 800 size per order = 45 orders
Ordering costs = 45 x P100 = 4,500.00
Carrying costs = [(800 / 2) x P24] = 9,600.00
Total inventory costs PPPP 14,100.00
3 Reorder point = Daily demand x lead time

Daily demand = Annual demand / working days
36,000 / 300 in units 120.00
Reorder point = 120 x 3 days in units 360.00
5.15
order sizes in dozens 26 50 100 130 200 2600
number of orders 100 52 26 20 13 1
average inventory 13 25 50 65 100 1300
carrying cost 39.00 75.00 150.00 195.00 300.00 3,900.00
ordering cost 700.00 364.00 182.00 140.00 91.00 7.00
total cost 739.00 439.00 332.00 335.00 391.00 3,907.00
5.16
1 Safety stock
Average monthly usage 780 units / 12 months = 65.00
Maximum usage 80.00
a Difference 15.00
b Lead time in months 1.00
(a x b) Safety stock (safety stock could be the difference 15.00
of average usage and maximum usage x lead time)
2 Reorder point = (monthly demand x lead time) + safety stock

65 x 1 month = 65 + 15 = 80.00
Note: Since maximum usage is given, reorder point will be the maximum usage
x the lead time which is one month, so we could take it just from there.
5.17
1 Annual cost of ordering = (Annual demand / order quantity ) x cost per order
Annual carrying cost = (Order quantity/ 2) x Annual carrying cost per unit
2 EOQ = 2 x D x CO
CU
= 2 x 4,800 x P150
P4.00
= 600
3 Total annual carrying and ordering costs

Ordering = (4,800 / 600) x P150 = 1,200.00
Carrying = (600/2) x P4.00 = 1,200.00
Total annual carrying and ordering costs 2,400.00
4 Number of orders per year

= 4,800 / 600 = 8 times
5 using the new cost data

a EOQ = 2 x D x CO
CU
= 2 x 4,800 x P20 = 100

P19.20
b Number of orders per year = 4,800 / 100 = 48 times
5.18
Inventory ordering and carrying costs table
Order sizes 400 600 800.00
Numer of orders per year at 4,800 demand 12 8 6.00
a Ordering costs at P150 per order 1,800.00 1,200.00 900.00
Average inventory (order size / 2) 200 300 400.00
b Carrying costs at P4.00 per unit 800.00 1,200.00 1,600.00
(a +b) Total ordering and carrying costs 2,600.00 2,400.00 2,500.00
Cost Number Total Carryng
5.19 Stock per of stockout cost per
levels Probability x stock orders cost unit
10 0.50 x 80.00 5 200.00 2.00
20 0.40 x 80.00 5 160.00 2.00
30 0.30 x 80.00 5 120.00 2.00
40 0.20 x 80.00 5 80.00 2.00
50 0.10 x 80.00 5 40.00 2.00
55 0.05 x 80.00 5 20.00 2.00
Safety stock level 55 showed the lowest stockout and carrying cost.
Total CC
Total Carrying Cost and Stockout
SS ( SS x CC /unit) cost
10 20.00 220.00
20 40.00 200.00
30 60.00 180.00
40 80.00 160.00
50 100.00 140.00
55 110.00 130.00
5.20
At current policy At proposed
Sales 810,000.00 850,500.00 P810,000 x 1.05
CMR 0.35 0.35
Contribution margin 283,500.00 297,675.00
Less, bad debts exp. 8,100.00 11,907.00
Net income before
cost of money on
uncollected accounts 275,400.00 285,768.00
Less 25% on uncollected
accounts * 22,500.00 30,375.00
NET INCOME 252,900.00 255,393.00
The company must adopt the new policy, quantitatively it increased its net income.
* Cost of money computed as follows:

Ave. A/R = 810,000.00 Ave. A/R = 850,500.00
9 times TO 7 times TO
90,000.00 121,500.00
Desired rate of return 0.25 Desired rate of return 0.25
Cost of money 22,500.00 Cost of money 30,375.00
Chapter 6 Short Term Financing Management
Answer Key
I. TRUE OR FALSE STATEMENTS Black – True; Red - False
1. The use of short-term debt provides flexibility in financing since the firm is only paying interest when it is using
the borrowed funds.
2. A firm can reduce net working capital by substituting long-term financing, such as bonds, with short-term
financing, such as one-year notes payable.
3. Notes payable is a spontaneous source of financing.
4. Increasing the use of short-term debt versus long-term debt financing will increase profit.
5. Current liabilities have greater illiquidity risk due to the higher frequency that they have to be repaid or rolled
over.
6. Trade credit is a source of spontaneous financing.
7. Short-term debt is frequently less expensive because it provides the borrower more security.
8. Sources of financing repaid in six months to one year are usually categorized as long-term.
9. Major sources of secured credit include commercial banks, finance companies, and factors.
10. Inventory loans are considered an unsecured source of financing.
11. The cost of trade credit varies directly with the size of the cash discount and inversely with the length of time
between the end of the discount period and the final due date.
12. The continual practice of stretching on trade credit is potentially a very useful source of short-term credit for
the firm.
13. The effective cost to the borrower of an unsecured bank loan is increased if a compensating balance is required.
14. Minimizing working capital is accomplished by slowing down the cash conversion cycle.
15. The conventional method for financing permanent levels of accounts receivable and inventory is accounts
payable and accrued expenses.
16. A firm should take the cash discount if the firm's cost of borrowing from the bank is greater than the cost of
giving up a cash discount.
17. If a firm anticipates stretching accounts payable, its cost of giving up a cash discount is reduced.
18. The cost of giving up a cash discount on a credit purchase is the implied interest rate paid in order to delay
payment for an additional number of days
19. In giving up a cash discount, the amount of the discount that is given up is the interest being paid by a firm to
keep its money by delaying payment for a number of days.
20. A revolving credit agreement is a form of financing consisting of short-term, unsecured promissory notes issued
by firms with a high credit standing.
II. MULTIPLE CHOICE QUESTIONS Encircle the letter that corresponds to the best answer.
1. Which of the following is a spontaneous source of financing?

a. Accrued wages
b. Preferred stock
c. Trade credit
d. Both a and c
2. Accounts receivable and inventory self-liquidate through the ______ cycle.

a. spontaneous account
b. net working capital
c. cash conversion
d. sales-to-receivables collection
3. Which of the following is considered a source of spontaneous financing?

a. Trade credit
b. Inventories
c. Accounts payable
d. Both a and c
4. With regard to the hedging principle, which of the following assets should be financed with current liabilities?
a. Minimum level of cash required for year-round operations
b. Expansion of accounts receivable to meet seasonal demands
c. Machinery used to produce a firm’s inventory
d. Both a and b
5. Trade credit is an example of which of the following sources of financing?

a. Spontaneous
b. Temporary
c. Permanent
d. Both a and b
6. Which of the following is a spontaneous source of financing?

a. Accounts payable
b. Accounts payable and wages and salaries payable
c. Accounts payable and inventories
d. Accounts payable, wages and salaries payable, and accrued interest
7. Which of the following types of financing offers the firm the greatest degree of flexibility?
a. Bonds
b. Preferred stock
c. Short-term lines of credit
d. Long-term notes payable
8. Which of the following actions would improve a firm’s liquidity?

a. Selling stock and reducing accounts payable
b. Selling stock to purchase equipment
c. Selling bonds and purchasing machinery
d. Both a and c
9. As sales increase, a company needs more inventory and more employees resulting in ________.
a. more accounts payable and accruals, and therefore increasing its spontaneous liabilities.
b. less accounts payable and accruals, and therefore decreasing its spontaneous liabilities.
c. more accounts payable and accruals, and therefore decreasing its spontaneous liabilities.
d. less accounts payable and accruals, and therefore increasing its spontaneous liabilities.
10. A negative cash conversion cycle ________.

a. means that the operating cycle exceeds the average inventory period.
b. means that the average payment period exceeds the operating cycle.
c. indicates that a firm is shortening its average payment period and lengthening its average collection
period.
d. indicates that a firm is shortening its average age of inventory and average payment period.
11. If a firm decides to take the cash discount that is offered on goods purchased on credit, the firm should
a. pay as soon as possible.
b. pay on the last day of the credit period.
c. pay on or before the last day of the discount period.
d. not take the discount no matter when the firm actually pays.
12. The effective interest rate generally is ________.
a. lower if the loan is a discount loan
b. higher if the loan is a discount loan
c. higher on a loan if interest is paid at maturity
d. not affected by whether the loan is a discount loan or a loan with interest paid at maturity
13. The cost of giving up a cash discount on a credit purchase is ________

a. the true purchase price of the goods
b. added on to the price of the goods in order to make payment quickly
c. deducted from the price of the goods in order to make payment quickly
d. the implied interest rate paid in order to delay payment for an additional number of days
14. Short-term loans that businesses obtain from banks and through commercial paper are ________.
a. negotiated and secured
b. negotiated and unsecured
c. spontaneous and secured
d. spontaneous and unsecured
15. Short-term, self-liquidating loans are intended to ________.

a. recapitalize the firm
b. provide maximum amount to the firm that it can owe to the bank
c. provide one-time loan to the borrower who needs funds for a specific purpose
d. cover seasonal peaks in financing caused by inventory and receivable buildups
III. MULTIPLE CHOICE PROBLEMS

Encircle the letter that corresponds to the best answer of the following problems.
1. What is the effective annualized cost of foregoing the trade discount on terms 2/10 net 80 (round to the nearest
.1%)?
a. 9.0%
b. 10.5%
c. 11.3%
d. 12.0%
2. What is the effective annualized cost of foregoing the trade discount with terms 2/15 net 70 (round to the nearest
.1%)?
a. 13.1%
b. 13.4%
c. 14.3%
d. 14.7%
3. Stanley Shoe Company established a line of credit with a local bank. The maximum amount that can be
borrowed under the terms of the agreement is P100,000 at an annual rate of 12%. A compensating balance
averaging 10% of the amount borrowed is required. Prior to the agreement, the company had no deposit with
the bank. Shortly after signing the agreement, the company needed P50,000 to pay off a note that was due. It
borrowed the P50,000 from the bank by drawing on the line of credit. What is the effective annual cost of
credit?
a. 13.2%
b. 13.3%
c. 13.6%
d. 13.9%
4. Smith & Smith Enterprises has a line of credit with National Bank that allows the company to borrow up to
P350,000 at an interest rate of 15%. However, the firm must keep a compensating balance of 10% of any amount
borrowed on deposit at the bank. The company does not normally keep a cash balance account with the bank.
What is the effective annual cost of credit?
a. 17.8%
b. 17.52%
c. 16.91
d. 16.67%
5. The Azurin Corporation was recently quoted terms on a commercial bank loan of 7% discounted interest with
a 20% compensating balance. The term of the loan is 1 year. The effective cost of borrowing is (rounded to the
nearest hundredth):
a. 8.75%.
b. 9.41%.
c. 9.52%.
d. 9.59%.
6. Salguero, Inc. can issue 3-month commercial paper with a face value of ₱1,000,000 for ₱980,000. Transaction
costs will be ₱1,200. The effective annualized percentage cost of the financing, based on a 360-day year, will
be:
a. 8.48%.
b. 8.66%.
c. 8.99%.
d. 9.02%.
7. When a company offers credit terms of 2/10, net 30, the annual interest cost, based on a 360-day year, is:
a. 24.0%.
b. 35.3%.
c. 36.0%.
d. 36.7%.
8. If a firm's credit terms require payment within 45 days but allow a discount of 2% if paid within 15 days
(using a 360-day year), the approximate cost or benefit of the trade credit terms is:
a. 14%.
b. 16%.
c. 20%.
d. 24%.
9. Tolentino, Inc. buys on terms of 2/10, net 30 days. It does not take discounts, and it typically pays 35 days
after the invoice date. Net purchases amount to P720,000 per year. What is the nominal annual cost of its
non-free trade credit?
a. 14%.
b. 16%.
c. 20%.
d. 24%.
10. Assume that the current borrowing rate is at 15%. Which of the following discounts should the firm take?
a. 2/10, net/45
b. 1/15, net/75
c. 3/10, net/80
d. 1/10, net/45
PROBLEMS
6.1
Assume that Lasaleta company purchase P5,000 worth of supplies every 60 days and never take the trade
discount of 2/10 net 60.
1. How much the company could save each (360-day) year if the company took the discount? P600
2. What is the effective annualized (365 days) cost of foregoing a trade credit discount of 3/10 net 45? 32.35%
6.2
.
Required:
1. What is the annual cost associated with each financing arrangement?
2. Discuss some considerations other than cost that may influence management’s decision between factoring
and a commercial bank loan.
1 Commercial bank loans

Amount loaned P250,000 x 75% 187,500.00
Discount P187,500 x ( 9%/12 months) (1,406.25)
Compensating balance = P187,500 x 20% (37,500.00)
Amount received 148,593.75
Annual costs:
Interest expense P187,500 x 9% 16,875.00
Credit department costs P4,000 x 12 months 48,000.00
Bad debts 2% x P250,000 x 12 months 60,000.00
Total annual costs 124,875.00
Factoring
Amount loaned P250,000 x 85% 212,500.00
Factoring commission P250,000 x 3.5% (8,750.00)
Prepaid interest (P212,500 - P8,750) x 9%/12 (1,528.00)
Amount received 202,222.00
Annual Costs
Annual Commissions P8,750 x 12 105,000.00
Annual Interest P203,750 x 9% 18,337.50
Total annual costs 123,337.50
2 The annual factoring costs are slightly lower than the cost of bank loan and the factor is willing to
advance greater amount. However, the elimination of the credit department could reduce the
firm's options in the future.
6.3
Carmen Traders, Inc. needs ₱100,000 to pay a supplier ’s invoice for merchandise purchased with terms of
2/10, net 30. The company wants to pay on the 10th day of the credit term so it can avail of the 2% discount.
The funds needed can be raised by obtaining a short-term loan from a bank which agrees to grant a 30-day
loan at 12% discounted interest per annum. The bank requires that a compensating balance of 10% be maintained
in the borrower’s non-interest earning deposit account.
Required:
1. What is the amount needed by Carmen Traders to pay the invoice within the discount period?
2. What is the principal amount of the loan that must be obtained from the bank to raise the needed fund?
3. What is the effective interest rate of the loan?
4. If Carmen Traders fails to pay the discount and pays the account on the 30th day of the term, what is the
annual cost of this non-free trade credit?
Answer
1) Invoice Amount ₱ 100,000
Less: 2% Discount 2,000
Net Amount of Funds Needed ₱ 98,000
2) Let x = Principal Amount of the Loan

98,000 = x – 0.10x 0 0.01x
98,000 = 0.89x
x = ₱ 110,112.36
3) Annual Interest Expense (₱ 110,112.36 × 12%) ₱ 13,213.48

/ Usable Loan Amount 98,000.00
Effective Annual Interest Rate 13.48%
4) 2 360
Annual Cost Rate =
98
× 30 - 10 = 36.73%
6.4
Cubone & Ive's Lithography has a Cost of Goods Sold of ₱ 95 million. The company's accounts payable
balance is ₱ 9.5 million. Calendar period: 360 days. Its accounts payable deferral period is __________ days.
Accounts Payable Deferral Period = 360 / ( ₱ 95 / ₱9.5 ) = 36 days
6.5
Graveler Mining plans to borrow ₱100,000 for one year under a line of credit with a stated interest rate of
7.5 percent and a 15 percent compensating balance.
Case A:
If the firm normally keeps a balance of about ₱10,000 in its checking account and is willing to accept loan
proceeds lesser than ₱100,000.
1. The loan proceeds would be ₱______________________ . (Round-off to 2 d.p.)
2. The interest to be repaid on the amount borrowed would be ₱______________________. (Round-off to 2
d.p.)
3. The effective annual interest rate on the loan is ________% (Round-off to 2 d.p.)
Case B:
If the fi rm normally keeps almost no money in its checking account. Loan proceeds: ₱100,000.
d.p.)
2. The amount borrowed would be ₱______________________ . (Round-off to 2 d.p.)
Answer:
A. If the firm normally keeps a balance of about ₱10,000 in its checking account and is willing to accept loan
proceeds lesser than ₱100,000.
1. The loan proceeds would be ₱______________________ . (Round-off to 2 d.p.)
Compensating฀Balance฀฀ =฀
1฀ 5%฀of฀Loan
= ₱100,000.00 x 15.00%
= ₱15,000.00 less:฀
D฀ D฀
₱฀ 10,000 ₱5,000.00
LOAN฀
PROCEEDS = ₱100,000.00 - ₱5,000.00
= ₱95,000.00
2. The interest to be repaid on the amount borrowed would be ₱______________________. (Round-off to 2 d.p.)
INT = ₱100,000.00 x 7.50% x 12฀/฀12

= ₱7,500.00 -฀
฀NOT฀DISCOUNTED,฀
w
฀ ill฀be฀repaid฀at฀end฀of฀term
APR = ₱7,500.00 x 1
₱100,000.00 - ₱5,000.00 12฀/1฀ 2
= 7.89%
B. If the firm normally keeps almost no money in its checking account. Loan proceeds: ₱100,000.

d.p.)
INT = ₱117,647.06 x 7.50%

= ₱8,823.53
BONUS: The amount borrowed would be ₱______________________ . (Round-off to 2 d.p.)
B = ₱100,000.00 / (100%฀
-฀1฀ 5%)
B = ₱100,000.00 / 85%
B = ₱117,647.06
Compensating฀Balance฀฀ =฀
1฀ 5%฀of฀Loan
= ₱117,647.06 x 15.00%
= ₱17,647.06
LOAN฀
PROCEEDS = ₱117,647.06 - ₱17,647.06
= ₱100,000.00
APR = ₱8,823.53
₱117,647.06 - ₱17,647.06
= 8.82%
6.6
A retailer’s terms of trade are 3/10, n/45 with a particular supplier. (assume a 360-day year)
Required:
What is the cost on an annual basis of not taking the discount? 31.81%
6.7
A company obtained a short-term bank loan of P250,000 at an annual interest rate of 6%. As a condition of
the loan, the company is required to maintain a 20% compensating balance in its checking account. Ordinarily, the
company maintains a balance of P25,000 in its checking account for transactions purposes.
Required:
What is the effective interest rate of the loan? 6.67%
6.8
NOP Co. has agreed to the following loan proposal by a bank:
▪ Stated interest rate of 10% on a one-year discounted note
▪ 15% of the loan as compensating balance with zero-interest current account to be maintained with the bank.
▪ The loan will have net proceeds of P1,500,000.
Required:
1. How much is the principal amount of the loan? P2,000,000
2. What is the effective interest rate of the loan? 13.33%
6.9
Quennie Company recently borrowed P500,000 from a bank. The bank loan is for a period of 120 days at an
annual rate of 6%. (assume a 360-day year).
Required:
1. How much is the total interest expense for this loan? P10,000
2. What is the effective annual rate? 6.12%
6.10
GHI Company has a revolving line of credit of P300,000 with a one-year maturity. The terms call for a 6%
interest rate and a ½% commitment fee on the unused portion of the credit line. The average loan balance during
the year was P100,000.
Required:
How much is the annual cost (in pesos) of this financing arrangement? P7,000
Chapter 7 Financial Planning
Answer Key
TRUE OR FALSE
1 TRUE 11 FALSE 21 FALSE
2 TRUE 12 TRUE 22 TRUE
3 FALSE 13 TRUE 23 FALSE
6 FALSE 16 FALSE 26 TRUE
9 FALSE 19 TRUE 29 TRUE
10 TRUE 20 TRUE 30 FALSE
MULTIPLE CHOICE QUESTIONS
1 D 8 A 15 D 22 B
2 B 9 D 16 D 23 C
3 D 10 A 17 C 24 D
4 A 11 C 18 A 25 C
5 B 12 C 19 B 26 D
6 B 13 D 20 D
7 D 14 A 21 D

1 D P140.000 AR from April Sales is equal to 15% balance
April total sales = P21,000 / 15% = 140,000.00
2 B March sales = P31,000 / 30% = 100,000.00

April sales = P33,000 / 30% = 110,000.00
Difference 10,000.00
3 C 9,000 units May June July

Sales 5,000 4,000 9,000
+ Ending inventory 1,600 3,600
= Total 6,600 7,600
- Beginning inventory 2,000 1,600
= Production 4,600 6,000 -
1 EI in May = 4,000 x 40% = 1,600
2 BI in May = 5,000 x 40% = 2,000
3 If june production is 6,000, budgeted EI in June is P3,600, as the balancing figure in June,
therefore, sales in July is P3,600 / 40% = P9,000
4 B 4,250 units FG Ending inventory = 40% of next month sales
1 card table = 3 hours at P13 per DLH ; direct labor cost = P136,500
Direct labor hours used = P P136,500 / P13 = 10, 500 hours
Production = 10,500 hrs / 3 hours per table = 3,500 card tables
Sales 3,000
+ Ending inventory 1,700 (40% of July sales ) *
= Total 4,700
- Beginning inventory 1,200 (40% of June sales)
= Production 3,500
* (40% of July sales = 1,700 / 40%) = 4,250
5 D 25,700 units Sales 25,000

+ Ending inventory 3,200 (10% x 32,000)
= Total 28,200
- Beginning inventory 2,500 (10% x 25,000)
= Production 25,700
6 C 408,000 lbs 1 unit of Product X = 2lbs of raw materials

Required production 200,000
lbs per unit 2
Raw materials used 400,000
Required Ending inventory 10,000
Total Available for use 410,000
Required Beginning inventory 2,000
Purchases 408,000
7 C P15,000 Sales commission P5 x 1,000 = 5,000.00

Administrative 10,000.00
Total 15,000.00
8 B P163,800 Sales 5,000

+ Ending inventory 1,200 40% of June = 3,000 x 40% = 1,200
= Total 6,200
- Beginning inventory 2,000 40% of May = 5,000 x 40% = 2,000
= Production 4,200
hours required per unit 3
total hours used 12,600
rate per hour 13.00
Direct labor cost 163,800
9 C P148.600 From june sales = P150,000 x 70% = 105,000.00
From May sales ( P48,000 / 30% ) x 15% = 24,000.00
Fro, April Sales (P21,000 / 15% ) x 14% = 19,600.00
Total collections in June 148,600.00
10 A P1,090,000 Beginning cash balance 50,000.00

Collections 1,000,000.00
Borrowings 70,000.00
Total cash available 1,120,000.00
Ending cash balance 30,000.00
Disbursements 1,090,000.00
11 D P100,000 April 1 cash balance 23,000.00

Collections 876,000.00
Total available 899,000.00
Disbursements 978,000.00
Deficiency (79,000.00)
Required minimum balance 20,000.00
Required borrowing (99,000.00)
Borrowings at multiples of P1,000 = P100,000 100,000.00
12 A P1,632,000 Mark up at 25%, therefore, sales = 1.25%

June sales = P2,040,000 = 1.25%
Cost of sales P2,040,000 / 1.25% = 1,632,000.00
13 C P1,767,200 July sales = P2,170,000 / 1.25% = 1,736,000.00

Req. EI = (P2,300,000 /1.25%) x 30% = 552,000.00
Total 2,288,000.00
Req. BI = (1,736,000 x 30%) 520,800.00
Required Purchases 1,767,200.00
14 A P14,250 From September sales P15,000 x 20% = 3,000.00

From August sales P10,000 x 50% = 5,000.00
From July sales P25,000 x 25% = 6,250.00
Total collections in september 14,250.00
15 B P4,600 October purchases P4,000 x 40% = 1,600.00

September purchases P5,000 x 60% = 3,000.00
Total disbursed to suppliers in October 4,600.00
16 D P4,400 November purchases P5,000 x 40% = 2,000.00

October purchases P4,000 x 60% = 2,400.00
Total disbursed to suppliers in November 4,400.00
17 C P16,290 December sales P17,500 x 60% x 98% = 10,290.00
November sales P15,000 x 40% 6,000.00
Total collections in December under the new plan 16,290.00
18 B 500 lbs 2 lbs = 1 unit

Production = 1,000 x 2 lbs = 2,000
Ending inventory (1,200 x 2 x .25) 600
Total 2,600
Beginning inventory (1,000 x 2 x .25) 500
Purchases # 20 2,100
19 B 700 lbs at march sales = 1,400 x 2 x 25% = 700
20 C 2,100 lbs refer to solutions in Number 18
21 A 2,400 lbs February production 1,200 x 2 = 2,400
21 A P801,400 July Collections include:

w/o disc May sales billed june 10, .18 x .50 x P700,000 63,000.00
with disc June sales billed july 10, .80 x .50 x P800,000 x .98 313,600.00
w/o disc June sales billed june 20, .18 x .50 x P800,000 72,000.00
with disc July sales billed July 20, .80 x .5 x P900,000 x .98 352,800.00
Total 801,400.00
22 B P433,800 September collections from August Sales:

August sales billed Sept. 10, .80 x .50 x P900,000 x .98 352,800.00
August sales billed August 20, .18 x .50 x P900,000 81,000.00
Total 433,800.00
23 D P120,000 .80 x .25 x P600,000 120,000.00
24 D P660,000 Ending inventory, .80 x .25 x next month's sales, P900,000 180,000.00
Merchandise needed this month .80 x P800,000 640,000.00
Total needed 820,000.00
Beginning inventory, .80 x .25 x P800,000 160,000.00
Purchases 660,000.00
25 C P690,000 July August

Ending inventory 180,000.00 120,000.00
Current COS 720,000.00 720,000.00
Total needed 900,000.00 840,000.00
Beginning inventory 180,000.00 180,000.00
Purchases 720,000.00 660,000.00
Payments, 1/2 of current purchases 360,000.00
1/2 preceding months 330,000.00
Total payments 690,000.00
26 A borrow P32,000 Cash balance beginning 15,000.00
Add, collections 90,000.00
Total 105,000.00
Less, disbursements (125,000.00)
Balance (20,000.00)
Required ending balance 12,000.00
Required borrowings 32,000.00
27 C 44,000 units april may june

budgeted sales 30,000.00 40,000.00 60,000.00
desired ending inventory 8,000.00 12,000.00
total requirements 38,000.00 52,000.00
desired beginning inventory 6,000.00 8,000.00
required production 32,000.00 44,000.00
28 A 105,000 units april may

required production 32,000.00 44,000.00
material X per unit x 3 lbs. x 3 lbs.
total requirements 96,000.00 132,000.00
desired ending inventory 33,000.00 (132,000 x 25%)
total requirements 129,000.00
desired beginning inventory 24,000.00 (96,000 x 25%)
required production 105,000.00
29 A P60,500 September sales

(P60,000 x 30%) 18,000.00
August sales (P70,000 x 50%) 35,000.00
July sales (P50,000 x 15%) 7,500.00
60,500.00
30 B P7,100 March P12,000 x 30% 3,600.00

February P5,000 x 70% 3,500.00
7,100.00
31 C P21,100 Paid to suppliers 7,100.00

labor cost P20,000 x 15% 3,000.00
other operating costs (P15,000 - P4,000) 11,000.00
21,100.00
32 D P14,000 March sales P20,000 x 40% 8,000.00

February salesP10,000 x 60% 6,000.00
14,000.00
33 A P2,900 Cash balance beginning 3,500.00
Add, collections in March 14,000.00
Less, payments in March (21,100.00)
Balance (3,600.00)
Required minimum balance 2,500.00
Amount borrowed 6,500.00
Cash balance ending ( P6,500 -3,600) 2,900.00
34 C 13,838 Total production 30,000 x 4 months 120,000

Less January sales 25,000
February sales2 5,000 x 1.04 26,000
March sales 26,000 x 1.04 27,040
April sales 27,040 x 1.04 28,122 106,162
Number of units on hand in April 13,838
35 D 450,000 units 480,000 + 50,000 - 80,000 = 450,000
PROBLEMS
7.1 April sales P200,000 x 8% = 16,000.00

May sales P420,000 x 50% = 210,000.00
June sales P350,000 x 40% = 140,000.00
Total collections in June 366,000.00
7.2 Product A Product B Product C

January February January February January February
Required EI 2,250 2,750 3,000 2,500 2,000 2,500
Projected sales 10,000 9,000 11,000 12,000 12,000 8,000
Total production 12,250 11,750 14,000 14,500 14,000 10,500
Required BI (2,500) (2,250) (2,750) (3,000) (3,000) (2,000)
Budgeted production 9,750 9,500 11,250 11,500 11,000 8,500
Material X Purchases
Product A Product B Product C
Production 9,750 9,500 11,250 11,500 11,000 8,500
x lbs required per unit 2 2 2 2 3 3
Total used 19,500 19,000 22,500 23,000 33,000 25,500
Required EI (19,000 + 23,000 + 25,500) x .50 = 33,750.00

Required in prodution for january (19,500 + 22,500 + 33,000 ) = 75,000.00
Total raw materials X required 108,750.00
Less, Required BI ( 75,000 x .50) = 37,500.00
Materials X to be purchased in January, in lbs 71,250.00
x Cost per lb of Material X 4.00
Budgeted Cost of Material X for January 285,000.00
Material Y Purchases
Production 9,750 9,500 11,250 11,500 11,000 8,500
Total used 29,250 28,500 11,250 11,500 22,000 17,000
Required EI (28,500 + 11,500 + 17,000) x .50 = 28,500.00

Total raw materials Y required 91,000.00
Materials Y to be purchased in January, in lbs 59,750.00
x Cost per lb of Material Y 3.00
Budgeted Cost of Material Y for January 179,250.00
Material Z Purchases
Production 9,750 9,500 11,250 11,500 11,000 8,500
Total used 19,500 19,000 22,500 23,000 22,000 17,000
Required EI (19,000 + 23,000 + 17,000) x .50 = 29,500.00

Total raw materials Z required 93,500.00
Materials Z to be purchased in January, in lbs 61,500.00
x Cost per lb of Material Z 5.00
Budgeted Cost of Material Z for January 307,500.00
Total budgeted cost of purchases of all raw materials for the month of January 771,750.00
7.3
Revenues 100,000.00
Less, Cost of goods sold 65,000.00
Gross Margin 35,000.00
Less. General & Administrative expenses 30,000.00
Net income before taxes 5,000.00
Income tax at 40% rate 2,000.00
* Cost of goods sold schedule
Raw materiasl used (production budget) 15,000.00
Direct labor costs (labor budget) 20,000.00
Manufacturing overhead (overhead budget) 20,000.00
Total current manufacturing costs 55,000.00
Add, Work in progress beginning 10,000.00
Total in process 65,000.00
Less, Work in progress ending 5,000.00
Total cost of goods manufactured 60,000.00
Add, Finished goods beginning 15,000.00
Total available for sales 75,000.00
Less, Finished goods ending 10,000.00
Cost of goods sold 65,000.00
7.4 Cash receipts:

From the month of sale - June P85,000 x 70% 59,500.00
From a month after sale - May P90,000 x 20% 18,000.00
From 2 months after sale - April P80,000 x 10% 8,000.00
Total 85,500.00
Cash Disbursements:
Purchases from May with discount P40,000 x 98% 39,200.00
Operating expenses 5,000.00
Total 44,200.00
Net change in cash for June - increase 41,300.00
7.5 a Actual of 2018 Budgeted of 2019

November December January February March
Sales 80,000.00 90,000.00 70,000.00 90,000.00 30,000.00
Purchases 70,000.00 80,000.00 70,000.00 60,000.00 50,000.00
Beginning cash balance 4,500.00 2,600.00 300.00

Cash receipts:
From current months sales 40% of sales 28,000.00 36,000.00 12,000.00
From prior month sales 60% balance 54,000.00 42,000.00 54,000.00
Total collections 82,000.00 78,000.00 66,000.00
Cash available 86,500.00 80,600.00 66,300.00
Cash disbursements:
From purchases:
From current month 20% of purchase 14,000.00 12,000.00 10,000.00
From 1 month after purchase 50% of purchase 40,000.00 35,000.00 30,000.00
From 2 months after purchae 30% of purchase 21,000.00 24,000.00 21,000.00
Total payments for purchase 75,000.00 71,000.00 61,000.00
Labor expenses 4,000.00 4,000.00 4,000.00
Sales salaries 2,000.00 2,000.00 2,000.00
Commissions at 2% of current months sales 1,400.00 1,800.00 600.00
Other expenses excluding depreciation of P500 1,500.00 1,500.00 1,500.00
Total cash disbursements 83,900.00 80,300.00 69,100.00
Ending cash balance 2,600.00 300.00 (2,800.00)
b Invest in January and February; Borrow for March

7.6
june july august
Sales budget
Credit sales 30% 120,000.00 132,000.00 150,000.00
Cash sales 70% 280,000.00 308,000.00 350,000.00
Total sales 100% 400,000.00 440,000.00 500,000.00
Cash collection budget
Cash sales this month 280,000.00 308,000.00 350,000.00
100% of last months credit sales 150,000.00 120,000.00 132,000.00
7.7
january february march
Sales budget
Credit sales 80% 144,000.00 168,000.00 216,000.00
Cash sales 20% 36,000.00 42,000.00 54,000.00
Total sales 100% 180,000.00 210,000.00 270,000.00
Cash collection budget
Cash sales this month 36,000.00 42,000.00 54,000.00
50% of this month's credit sales 72,000.00 84,000.00 108,000.00
40% of last month's credit sales 60,800.00 57,600.00 67,200.00
10% of next-to- last month's credit sales 20,000.00 15,200.00 14,400.00
7.8 Collections from:

January sales P300,000 x 12% 36,000.00
February sales P400,000 x 10% x 99% 39,600.00
P400,000 x 25% 100,000.00
March sales P500,000 x 50% x 99% 247,500.00
Total cash collections 423,100.00
7.9 Budgeted Cash Receipts and Disbursements for April:

Cash balance, March 31 80,000.00
Add, Collections from customers:
From April sales, 50% x P1,000,000 500,000.00
From March sales, 4/5 x P450,000 360,000.00
From February sales 60,000.00 920,000.00
Total cash available fefore current financing 1,000,000.00
note that the AR balance from March sales at March 31 is P450,000, therefore 4/5 will be received in April.
Less, Disbursements:
Merchandise purchases, P500,000 x 40% 200,000.00
Payment on Accounts Payable 450,000.00
Payrolls 90,000.00
Insurance premium 1,500.00
Other expenses 45,000.00
Repayment of loan and interest 94,500.00 881,000.00
Cash balance, April 30 119,000.00
7.10 june july august
Purchases budget:
Desired Ending inventory 220,000.00 270,000.00 230,000.00
Desired Cost of sales, 60% of sales 264,000.00 210,000.00 240,000.00
Total requirements 484,000.00 480,000.00 470,000.00
Desired Beginning inventory 250,000.00 220,000.00 270,000.00
Desired Purchases 234,000.00 260,000.00 200,000.00
Disbursements for purchases

10% of this month's purchases 23,400.00 26,000.00 20,000.00
80% of last month's purchases * 144,000.00 187,200.00 208,000.00
10% of second last month's purchases ** 25,000.00 18,000.00 23,400.00
192,400.00 231,200.00 251,400.00
P180,000 x 80% = P144,000 *
P250,000 x 10% = P25,000 **
7.11
July August September
Desired Production a 10,000 8,000 20,000
Desired usage per pencil b 10 10 10
Required usage per 1 foot c = (a / b) 1,000 800 2,000
Desired Ending inventory d 160 400 480
Total Requirements e =(c + d) 1,160 1,200 2,480
Desired beginning inventory f 200 160 400
Desired purchases g (e - f) 960 1,040 2,080
converted to an eight foot section g/8 8 8 8
number of pcs. In and 8-ft per pc. h 120 130 260
Price per eight foot section I 2.00 2.00 2.00
Total Budgeted Purchases j = (h x I) 240.00 260.00 520.00
7.12
a Summary of collections
October November December
Current month's collections:
October P12,500 x 25% x 97% 3,031.25
November P20,000 x 25% x 97% 4,850.00
December P35,000 x 25% x 97% 8,487.50
Month following sale:
October P15,000 x 60% 9,000.00
November P12,500 x 60% 7,500.00
December P20,000 x 60% 12,000.00
Two months following sale:
October P10,000 x 13% 1,300.00
November P15,000 x 13% 1,950.00
December P12,500 x 13% 1,625.00
13,331.25 14,300.00 22,112.50
b Summary of cash disbursements
October November December
Current month's purchases:
October P4,000 x 20% x 98% 784.00
November P6,000 x 20% x 98% 1,176.00
December P5,000 x 20% x 98% 980.00
Month following purchases:
October P5,000 x 80% 4,000.00
November P4,000 x 80% 3,200.00
December P6,000 x 80% 4,800.00
4,784.00 4,376.00 5,780.00
7.13 Bestwood, Inc.

Statement of Cash Receipts and Disbursements
For the month of October,
Cash balance beginning 12,000.00
Add:Cash Receipts
Collection of accounts receivable
Month of sale (P50,000 x 30% x 98%) 14,700.00
Month following sale (P40,000 x 50%) 20,000.00
Two months following sale (P20,000 x 17%) 3,400.00 38,100.00
Issuance of common stock 4,000.00 42,100.00
Total Cash available 54,100.00
Less:Cash Disbursements
Payments of accounts payable
Month of purchase (P28,000 x 30% x 97%) 8,148.00
Month following purchase (P24,000 x 70%) 16,800.00 24,948.00
Labor costs (P50,000 x 10%) 5,000.00
Operating costs (P20,000 - P8,000) 12,000.00
Dividends 10,000.00 51,948.00
Cash balance , ending 2,152.00

Minimum required cash balance 6,000.00
Required additional cash 3,848.00
Amount to be borrowed 4,000.00
Cash balance ending 6,152.00
7.14
1 Purchasing automated assemby equipment:
Increase in variable overhead P80,000 x 12% 9,600.00
Increase in fixed costs 20,000.00
Decrease in direct labor cost P80,000 x 30% (24,000.00)
Net increase in costs , means decrease in profits 5,600.00
2 Reduce the unit selling price by P2 per unit:
Increase in sales due to increase in volume (P28 x 40,000) - P600,000 520,000.00
Less: Increase in variable costs (20,000 x (P320,000 / 20,000) (320,000.00)
Increase in fixed factory overhead (16,000.00)
Increase in net income 184,000.00
7.15
a Collections for the month of December
November sales P200,000 x 38% 76,000.00
December sales P220,000 x 60% 132,000.00
208,000.00
b Compute the budgeted income or loss for December
(Please indicate additional requirement omitted in the textbook)
Sales 220,000.00
Less Cost of sales (75% of sales) 165,000.00
Gross Profit 55,000.00
Less Operating Expenses:
Bad debts expense (2% of sales) 4,400.00
Depreciation expense (P216,000 / 12 months) 18,000.00
Other expenses 22,600.00 45,000.00
Net income before income taxes 10,000.00
7.16 Camelott Company

Budgeted Income Statement
For the year Ended November 30, 2008
In thousands
Net sales P8,400 x 1.05 x 1.10 9,702.00
Less Cost and expenses:
Cost of sales P6,300 x 1.05 x 1.04 6,879.60
Marketing Expenses P780 + 420 1,200.00
Interest expense (P300 x .10 ) = P30 + P140 170.00 8,249.60
Income tax at 40% 580.96
Net income after taxes 871.44
7.17
1 Sales 30,000.00
Less, Cost of goods sold 12,000.00
Gross profit 18,000.00
Less, Expenses:
Bad debts P30,000 x 2% 600.00
Depreciation 5,000.00
Other Marketing & Adm. 9,000.00 14,600.00
Income tax at 40% 1,360.00
Net income after taxes 2,040.00
2 Collections in July
Month of sale P40,000 x 50% 20,000.00
Month following sale P30,000 x 48% 14,400.00
Total collections 34,400.00
3 Cash disbursements in July

Payment of Accounts Payable
Month of purchases P15,000 x 25% 3,750.00
Following month of purchase
P10,000 x 75% 7,500.00 11,250.00
Income tax 1,360.00
Marketing and administrative 10,000.00
Dividends 15,000.00
Total disbursements 37,610.00
4 Cash balance beginning 5,000.00

Add Collections 34,400.00
Total available 39,400.00
Less Disbursements 37,610.00
Cash balance ending 1,790.00
Required minimum cash balance 5,000.00
Amount to be borrowed 3,210.00
CASH BALANCE ENDING 5,000.00
7.18
1 Accumulated Depreciation, 12 /31/19 P790,000 + P140,000 930,000.00
2 Retained earnings 12/31/19

Beginning 1,650,000.00
Dividends paid -
Retained earnings ending 2,050,000.00
3 Accounts receivable 12/31/19 P100,000 + P900,000 - P780,000 220,000.00
4 Payments of accounts payable in 2019 P1,200,000 - P300,000 900,000.00
5 January February March

Sales 60,000.00 80,000.00 90,000.00
Cash receipts from:
Cash sales 30,000.00 40,000.00 45,000.00
Accounts Receivable 49,000.00 36,000.00 43,000.00
Total 79,000.00 76,000.00 88,000.00
7.19
January February March April May June
SALES 300,000.00 400,000.00 550,000.00 925,000.00 725,000.00 475,000.00
CASH BALANCE, BEGINNING 50,000.00 50,000.00 50,000.00 50,000.00 50,000.00 50,000.00
COLLECTIONS:
MONTH OF SALE 20% OF SALES 60,000.00 80,000.00 110,000.00 185,000.00 145,000.00 95,000.00
MONTH AFTER SALE 60% OF SALES 45,000.00 180,000.00 240,000.00 330,000.00 555,000.00 435,000.00
2ND MONTH AFTER SALE 20% OF SALES 10,000.00 15,000.00 60,000.00 80,000.00 110,000.00 185,000.00
TOTAL COLLECTIONS 115,000.00 275,000.00 410,000.00 595,000.00 810,000.00 715,000.00
TOTAL CASH AVAILABLE 165,000.00 325,000.00 460,000.00 645,000.00 860,000.00 765,000.00
LESS, DISBURSEMENTS:
ADMINISTRATIVE SALARIES 25,000.00 25,000.00 25,000.00 25,000.00 25,000.00 25,000.00
LEASE PAYMENTS 20,000.00 20,000.00 20,000.00 20,000.00 20,000.00 20,000.00
MISCELLANEOUS OVERHEAD 10,000.00 10,000.00 10,000.00 10,000.00 10,000.00 10,000.00
QUARTERLY INCOME TAX 125,000.00 125,000.00
CUTTING MACHINE 250,000.00
WAGES AND PRODUCTION 175,000.00 175,000.00 250,000.00 275,000.00 425,000.00 175,000.00
230,000.00 230,000.00 430,000.00 580,000.00 480,000.00 355,000.00
CASH BALANCE ( DEFICIT) (65,000.00) 95,000.00 30,000.00 65,000.00 380,000.00 410,000.00
CASH BALANCE REQUIREMENT 50,000.00 50,000.00 50,000.00 50,000.00 50,000.00 50,000.00
MONTHLY LOAN REQUIREMENT 115,000.00 - 20,000.00 - - -
MONTHLY LOAN PAYMENT 45,000.00 15,000.00
MONTHLY LOAN BALANCE 70,000.00 90,000.00 75,000.00 75,000.00 -
CASH EXCESS - POSSIBLE TEMPORARY INVESTMENTS 255,000.00 360,000.00
The firm's maximum loan requirement is P115,000
The firm's maximum surplus balance is in June which is P360,000.
7.20
1 Breakeven analysis is a method of determining the point at which sales will just cover costs, and it
shows the magnitude of the firm's profits or losses if sales exceed or fall below that point.
Breakeven point in units = P1,770,000 / (P40 - P16) = 73,750.00 units
Breakeven point in pesos = 73,750 units x P40.00 = 2,950,000.00

or P1,770,000 / (P24 / P40.00) = 2,950,000.00
2 Cash breakeven point is the breakeven point when noncash items are subtracted from fixed costs.
cash breakeven point = (P1,770,000 - P360,000) / P24 = 58,750.00 units
58,750 units x P40.00 2,350,000.00
3 Operating leverage is a measure of the extent to which fixed costs are used in a firm's operations.
a firm with a high percentage of fixed costs is said to have a high degree of operating leverage.
Sales 100,000 units x P40.00 4,000,000.00

Less, Variable costs 100,000 x P16 1,600,000.00
Contribution margine 2,400,000.00
Less, fixed costs 1,770,000.00
operating leverage factory P2,400,000 / P630,000 3.81
or it can be computed as follows

Q(P - V) 100,000.00 x (P40 - P16) 2,400,000.00
Q(P - V) - F 100,000.00 x(P40 - P16)-P1,770,000 630,000.00
= 3.81
Chapter 8
Time Value of Money - Key
TRUE OR FALSE MULTIPLE CHOICE

1. F 1. B
2. T 2. B
3. T 3. B
4. F 4. C
5. T 5. C
6. F 6. B
7. T 7. C
8. T 8. A
9. T 9. C
10. T 10. A
11. F 11. E
12. T 12. B
13. T 13. D
14. T 14. E
15. F 15. E
16. T 16. C
17. T 17. E
18. T 18. E
19. T 19. E
20. F 20. A
21. F 21. A
22. T 22. B
23. F 23. B
24. F 24. A
25. F 25. C
26. F 26. C
27. T 27. B
28. F 28. D
29. F 29. A
30. F 30. C
MULTIPLE CHOICE – PROBLEMS (30 items)
1. A
P5,000 × 1.16986 (4 periods and 4%) = P5,849.30
2. C
P1,000,000 x .53464 (6 periods and 11%) = P534,640
3. D
P25,000 x 1.2167 (5 periods and 4%) = P30,416
4. B
P1500 x .8116 (2 periods and 11%) = P1,217.43
5. C
P50,000 by 1.21 ( future value of 1 factor)
6. C. 25,000 x ((1.13^9)-1)/(0.13)
7. D. 25,000 x (((1.13^9)-1)/0.13) (1.13)
8. D. 10,000/7% = 142, 857

9. B. 7,500 x (((1.10^8)-1)/0.10)(1.10)
10. C. 7,500 (((1.10^8)-1)/0.10)
11. B
Net cash
Year flow PV of 1 at 11% PV
1 1,000 0.9009 900.90
2 2,000 0.8116 1,623.20
3 3,500 0.7312 2,559.20
4 4,000 0.6587 2,634.80
TOTAL 7,718.10
12. A
Net cash
Year flow FV of 1 at 8% FV
1 5,000 1.3605 6,802.50
2 2,000 1.2597 2,519.40
3 500 1.1664 583.20
4 10,000 1.08 10,800.00
TOTAL 20,705.10
13. B
Machine A
PV=2000x3.0373= 6074.6
Machine B
Net cash
Year flow PV of 1 at 12% PV
1 1,000 0.8929 892.90
2 2,000 0.7972 1,594.40
3 2,000 0.7118 1,423.60
4 1,500 0.6355 953.25
TOTAL 4,864.15
14. D
PV of 1 at
Year Net cash flow 11% PV
1 1,000 0.9009 901
2 1,000 0.8116 812
3 1,000 0.7312 731
4 1,500 0.6587 988
5 1,500 0.5935 890
6 1,500 0.5346 802
7 2,000 0.4817 963
8 2,000 0.4339 868
9 2,000 0.3909 782
TOTAL 7,737
15. C
Net cash FV of 1 at
Year flow 9% FV
1 500 1.1881 594.05
2 600 1.09 654.00
TOTAL 1,248.05
16. B
P= 2,000. r= 16%. n= 5. m= 4
FV= 2,000 ( 1+ .16/4 )^5*4
= 2,000 ( 2.191123143 )
= ₱ 4,382.25
17. D.
P= 2,500. r= 9%. n= 8 m= 2
FV = 2,500 ( 1 + .09/2 )^8*2
= 2,500 ( 2.022370153 )
= ₱5,055.93
18. C.
P= 6500. r= 8%. n=7. m=12
FV= 6,500 ( 1+ .08/12 )^7*12
= 6,500 ( 1.747422051 )
= ₱11,358.24
19. B.
P = 20,000. r= 6%. n= 3. m= 1
FV = 20,000 ( 1 + .06 )^3
= 20,000 (1.191016)
=₱23,820
20. A.
₱23,820-₱20,000= ₱3,820.32
21. Answer: D – 23.62%
Let x be the annual rate of return of the bond:

500 = 60 × (1 + 𝑋)10
𝑋 = 23.62%
Topic: Finding interest
22. Answer: C – 3.41%
Let x be the growth rate of the dividend over the last 15 years:
8 = 5 × (1 + 𝑋)14
𝑋 = 3.41%
Topic: Finding growth rate
23. Answer: Letter B – 9.22 years
Let x be the unknown number of periods:

(1 + .18) 𝑋 − 1
10, 000, 000 = 500, 000 ×
. 18
𝑋 = 9.22 𝑦𝑒𝑎𝑟𝑠
Topic: Finding unknown number of periods
24. Answer: C – 6.22%
Let x be the annual rate of return in Joshlia’s deposit:

(1 + 𝑋)20 − 1
800, 000 = 20,000 × × (1 + 𝑋)
𝑋
𝑋 = 6.22%
Topic: Finding interest rate
25. Answer: A – 24 years

(1 + .07) 𝑋 − 1
290, 000 = 5000 ×
. 07
𝑋 = 24 𝑦𝑒𝑎𝑟𝑠
Topic: Finding unknown number of periods
26. A = P ( 1 + r/n )^nt
2P = P ( 1 + r/n )^nt
2 = ( 1 + r/n )^nt
2 = ( 1 + .03/12)^12t
log 2 = log ( 1 + .03/12)^12t
log 2 = 12t log ( 1.0025 )
log (1.0025)
277.60553016 = 12t
12
23.13 = t
27. A.
FV= 12,000. r= 9% n=6. m=12
12,000= P ( 1+ .09/12 )^12*6
12,000= P ( 1.712552707 )
P= ₱7,007.08
28. B.
FV= 9,350 PV=5,000. r=8.25%. m=2. t=?
9,350= 5,000 ( 1+ .0825/2 )^2t
5,000
1.87 = (1.04125)^2t
log 1.87 = log (1.04125)^2t
log 1.87 = 2t log (1.04125)
log (1.04125)
15.48512579=2t
2
7.74 = t
29. C.
FV= 12,400 PV=8,000. r=7%. m=4. t=?
12,400=8,000 ( 1 + .07/4 )^4t
8,000
1.55= ( 1.0175 )^4t
log 1.55= log( 1.0175 )^4t
log 1.55= 4t log( 1.0175 )
log (1.0175)
25.26163279=4t
4
6.32= t
30. B
Time Line:
0 i = 5.127% 1 2 20 Years
| | | • • • |
PV = -15,000 FV = ?
Numerical solution:
FV20 = PHP15,000e0.05(20) = PHP40,774.23 PHP40,774.
CASE PROBLEMS SOLUTIONS
CASE PROBLEM 1
A.
8% 1.5𝑥4
=P1000 x (1 + )
4
=P1000 x 1.1262 = P1126
B.
10% 1.5𝑥4
=P1000 x (1 + )
4
=P1000 x 1.1597 = P1160
C
8% −1.5𝑥4
=P1500 x (1 + )
4
=P1500 x .8880 = P1332
CASE PROBLEM 2
A.
=P1,000,000 x (1 + 6%)−3
=P1,000,000 x .8396 = P839,619
B
=P1,000,000 x (1 + 6%)3
=P1,000,000 x 1.1910 = P1,191,016
C. Elect to receive the value three years from now because it earns interest yearly.
CASE PROBLEM 3
1. Option B
2. FVA = PMT (FVIFA) = 14,000(11.028) = P 154,392
3. FVA = PMT (FVIFA) = 20,000(6.105) = P 122,100
P 130,000 – 122,100 = P 7,900 deficiency
CASE PROBLEM 4
1. PV Annuity Due = 975,000 ((1-(1.14^-5))/0.14)(1.14) = 3,815,869.49

2. PV OA = 975,000 ((1-(1.18^-5))/0.08) = 3892892.29
3. PV Annuity Due = 975,000 ((1-(1.10^-5))/0.10)(1.10) = 4,065,618.81
4. The company should choose option #3.
CASE PROBLEM 5
1. The PV of A = P 435,000
2. The PV of B = 100,000 (((1-(1.05^-5))/0.05)
3. Option A.
CASE PROBLEM 6
Net Cash Flow PV of Cash Flow

Year PV of 1 at 12%
Xia Yen Xia Yen
1 8,000 6,000 0.8929 7,143.20 5,357.40
2 6,000 4,000 0.7972 4,783 3,188.80
3 4,000 2,000 0.7118 2,847.20 1,423.60
4 2,000 8,000 0.6355 1,271 5,084
Total 20,000 20,000 16,044.60 15,053.80
1.) 16,044.60
2.) 15,053.80
3.) Proposal Xia
CASE PROBLEM 7
Bank A P= ₱30,000. R=10%. M=12 T=8

FV = 30,000 ( 1 + .10/12 )^8*12
= 30,000 (2.218175631)
= ₱66,545.27
Bank B. P= ₱30,000. R=6%. M=2 T=8

FV = 30,000 ( 1 + .06/2 )^8*2
= 30,000 (1.604706439)
= ₱48,141.19
1. Interest Income
Bank A= ₱66,545.27 - ₱30,000 = ₱36,545.27
Bank B= ₱48,141.19 - ₱30,000 = ₱18,141.19
2. Bank A P= ₱30,000. R=10%. M=12 T=8

FV = 30,000 ( 1 + .10/12 )^8*12
= 30,000 (2.218175631)
= ₱66,545.27
Bank B. P= ₱30,000. R=6%. M=2 T=8

FV = 30,000 ( 1 + .06/2 )^8*2
= 30,000 (1.604706439)
= ₱48,141.19
3. Bank A will help him acquire more interest with ₱66,545.27
CASE PROBLEM 8
Marco
P= ₱15,000. R=9%. M=4. N=4
FV = 15,000 ( 1 + .09/4 )^4*4
= 15,000 ( 1.427621457 )
= ₱21,414.32
Brent
P= ₱20,000. R=10% M=2 N=4
FV = 20,000 ( 1 + .10/2 )^4*2
= 20,000 ( 1.477455444 )
= ₱29,549.11
1. ₱21,414.32 - ₱15,000 = ₱6,414.32 interest income of Marco
Marco
P= ₱15,000. R=9%. M=4. N=4
FV = 15,000 ( 1 + .09/4 )^4*4
= 15,000 ( 1.427621457 )
= ₱21,414.32
Brent
P= ₱20,000. R=10% M=2 N=4
FV = 20,000 ( 1 + .10/2 )^4*2
= 20,000 ( 1.477455444 )
= ₱29,549.11
Marco
P= ₱15,000. R=9%. M=4. N=4
FV = 15,000 ( 1 + .09/4 )^4*4
= 15,000 ( 1.427621457 )
= ₱21,414.32
Brent
P= ₱20,000. R=10% M=2 N=4
FV = 20,000 ( 1 + .10/2 )^4*2
= 20,000 ( 1.477455444 )
= ₱29,549.11
2. Marco
P= ₱15,000. R=9%. M=4. N=4
FV = 15,000 ( 1 + .09/4 )^4*4
= 15,000 ( 1.427621457 )
= ₱21,414.32
Brent
P= ₱20,000. R=10% M=2 N=4
FV = 20,000 ( 1 + .10/2 )^4*2
= 20,000 ( 1.477455444 )
= ₱29,549.11
3. ₱21,414.32 - ₱15,000 = ₱6,414.32 interest income of Marco

₱29,549.11 - ₱20,000 = ₱9,549.11 interest income of Brent
CASE PROBLEM 9
A) P12, 175
Year Future
Value
1 2, 000*1.08^3 P2, 519
2 2, 500*1.08^2 2, 916
3 3, 000*1.08^1 3, 240
4 3, 500 *1.08^0 3, 500
Total P12, 175
B) 10%
Year Future Value of
Value X –
Interest
Rate
1 2, 000*1+X^3 P2, 662 10%
2 2, 500*1+X^2 3, 025 10%
3 3, 000*1+X^1 3, 300 10%
4 3, 500 *1+X^0 3, 500 10%
Total P 12, 487
C) 2nd year
(1 + .08) 𝑋 − 1
2426 = 1000 ×
. 08
𝑋 = 2.30 ; 𝑜𝑛 ℎ𝑒𝑟 2𝑛𝑑 𝑦𝑒𝑎𝑟 𝑎𝑠 𝑎 𝑐𝑜𝑙𝑙𝑒𝑔𝑒 𝑠𝑡𝑢𝑑𝑒𝑛𝑡
CASE PROBLEM 10
A) 5.45%
Let x be the rate of return on James Reid’s investment:
8, 500, 000 = 5, 000, 000 × (1 + 𝑥)10
𝑋 = 5.45%
B) 58.58%
Let x be the rate of return on James Reid’s investment:
(1 + 𝑋)10 − 1
8, 500, 000 = 50, 000 ×
𝑋
𝑋 = 58.58%
C) 18.8 years
8, 500, 000 = 2, 000, 000 × (1.08) 𝑋
𝑋 = 18.8 𝑦𝑒𝑎𝑟𝑠
D) Bank A; FV= 11, 040, 198.32
Bank A:
. 08 10×4
𝐹𝑉 = 5, 000, 000 × (1 + )
4
𝐹𝑉 = 11, 040, 198. 32
Bank B:
. 08 10×2
𝐹𝑉 = 5, 000, 000 × (1 + )
2
𝐹𝑉 = 10, 955, 615.72
Chapter 9
Capital Budgeting - Key
I TRUE OR FALSE

3 TRUE 23 FALSE 43 TRUE
4 FALSE 24 FALSE 44 FALSE
10 TRUE 30 FALSE 50 FALSE
13 FALSE 33 FALSE
14 TRUE 34 TRUE
15 FALSE 35 FALSE
16 TRUE 36 TRUE
17 TRUE 37 FALSE
18 TRUE 38 TRUE
19 TRUE 39 FALSE
20 FALSE 40 FALSE
II MULTIPLE CHOICE QUESTIONS

1 A 16 B 31 B
2 B 17 D 32 C
3 D 18 C 33 D
4 C 19 D 34 C
5 B 20 D 35 C
6 A 21 B 36 C
7 C 22 D 37 A
8 A 23 D 38 D
9 C 24 C 39 B
10 B 25 B 40 A
11 D 26 D 41 B
12 D 27 D 42 A
13 C 28 A 43 D
14 C 29 D 44 C
15 B 30 B 45 C
1 C 13 C 25 C
2 B 14 B 26 D
3 B 15 C 27 B
4 D 16 B 28 C
5 C 17 C 29 B
6 B 18 C 30 C
7 B 19 B 31 B
8 D 20 C 32 A
9 D 21 D 33 B
10 B 22 B 34 C
11 B 23 C 35 B
12 C 24 A 36 A
SOLUTIONS TO MULTIPLE CHOICE PROBLEMS
#1 investment years
year recovered unrecovered recovered
at y-0 105,000.00 -
1 50,000.00 55,000.00 1
2 45,000.00 10,000.00 1
3 10,000.00 - 0.25 (P10,000 / P40,000) = .25
2.25 payback
or
2 years + (P105,000 - P95,000) = 2.25 years
P 40,000
#2 Average Net income = P95,000 / 5 years = P19,000

ARR = P19,000 / P105,000 = 18.095 or 18.10%
#3 Total present values of cash inflows

year PV CASH PRESENT
FACTOR FLOWS VALUES
1 0.81 50,000.00 40,500.00
2 0.65 45,000.00 29,250.00
3 0.52 40,000.00 20,800.00
4 0.42 35,000.00 14,700.00
5 0.34 30,000.00 10,200.00
Total present values of cash inflows 115,450.00
Initial investment cost 105,000.00
Net present value 10,450.00
#4 Present value = P56,000 x 2.531 = 141,736.00

Initial investment cost 140,000.00
#5 Present value 20,000.00 x 2.531 50,620.00
Initial investment 50,000.00
Profitability index P50,620 / P50,000 1.01
#6 PV Factor = Investment / Annual cash flows = P68,337 / P27,000 = 2.531

2.531 is at 9%
#7 Present value = P30,000 x 2.487 = 74,610.00
#8 Payback period = P400,000 / P100,000 = 4 years
#9 Present values = P142,000 x 4.355 = 618,410.00

Initial investment = 600,000.00
#10 Accounting Rate of Return (ARR) = P20,000 / (410,000 / 2) = P20000 / P200,000 = 10%
#11 PV Factor = P600,000 / P142,000 = 0.42254

between 4.1111 and 4.3555 approximately 11%
#12 Revenues 90,000.00

Operating costs 38,000.00
Depreciation P320,000 / 8 years 40,000.00 78,000.00
Annual net income 12,000.00
ARR = P12,000 / (P320,000 / 2) = 0.0750
#13 Net income 12,000.00

Depreciation expense 40,000.00
Annual cash flows 52,000.00
Payback P320,000 / P52,000 = 0.6154
or 6.2 years
#14 ARR = Net income / Average investments = P60,000 = 30%

(P300,000 + P100,000) / 2
#15 Average investment = (P80,000 + P4,000 ) / 2 = 42,000.00
#16 year PV Factor at 15% Cash Flows Present Values

1 0.8700 x 100,000.00 = 87,000.00
2 0.7560 x 160,000.00 120,960.00
Total PV of cash inflows 207,960.00
#17 year PV Factor at 14% Cash Flows Present Values

1 0.8800 x 15,000.00 = 13,200.00
2 0.7700 x 15,000.00 11,550.00
3 0.6700 x 10,000.00 6,700.00
Total PV of cash inflows 31,450.00
#18 Payback = P200,000 / P40,000 = 5.00 years

#19 PV of P1 at 12% = P24,600 x 3.605 = 88,683.00
#20 Payback = P600,000 / P225,000 = 2.6667 years
#21 Present value factor = P30,000 / P7,300 = 4.1095

4.231 and 4.111 in between is 4.1095 is at 12%
4.2310 0.12150
4.1095 in between
4.1110 (0.0015)
#22 Present value = P7,300 x 4.355 at 10% 31,791.50

Initial investment 30,000.00
Net present value 1,791.50 1,792.00
#23 Profitability index = P31,792 / P30,000 = 1.0597 1.06
Savings on labor 8,000.00

less, increased in power costs (1,000.00)
net savings 7,000.00
PV of 12% for 10yrs x 5.65
#24 PV of savings = 39,550.00
Less ,Investment costs 30,000.00
#25 Net present value = 9,550.00
#26 Investment / annual cash flow = Factor of Time Adjusted Rate Of Return
P84,900 / P15,000 = 5.660 this is in Table 4 14% 12 years 14%
#27 Return in five (5) years 10,000.00

factor for 12% for 5 yrs at Table 3 0.5670
PV and the maximum amount that the company would be willing to invest. 5,670.00
#28 factor at present

years amount 18% value
a b c d
(b x c)
Working capital now (30,000.00) 1.00 (30,000.00)
cash inflow 1 - 6 years 10,000.00 3.50 34,980.00
working capital released 6 30,000.00 0.37 11,100.00
net present value 16,080.00
#29 P100,000 / P25,000 = 4 years
#30 investment outflow inflows balance

year 1 (50,000.00) (50,000.00)
2 20,000.00 (30,000.00)
3 20,000.00 (10,000.00)
4 (50,000.00) 20,000.00 (20,000.00)
5 20,000.00 -
payback is 5 years or at year 5
#31 Net income = (P30,000 - {P100,000 - P10,000}) = P30,000 - P18,000 = 12,000.00
5 years
AROR = P12,000 / { (P100,000 + P10,000)/ 2 } = 21.81% or 22%
#32 P50,000 x 30% = P15,000
#33 Profitability Index (PI) = PV of cash inflow P50,000 = 1.25

Investment P40,000
#34 Payback = P30,000 / P6,000 = 5 years
#35 Cash flows 6,000.00

Less, depreciation (P30,000 / 5 years) 2,000.00
Net savings 4,000.00 P4,000 / P30,000 = 13.30%
#36 Working capital is an investment not an expense, so no tax adjustment is needed
PROBLEMS
9.1 Cost 475,000.00

Delivery and set up costs 12,500.00
Total investment costs 487,500.00
Average income per year 5 days x 52 weeks x P400 = 104,000.00
Less, Average operating costs per year 5 days x 52 weeks x P25 6,500.00
Cash net income 97,500.00
Less, Depreciation costs (P487,500 - P27,500) / 10 years = 46,000.00
a Cash payback P487,500 / P97,500 = 5.00 years
b Present values of annual inflows P97,500 x 6.418 10years at 9% 625,755.00

Present values of salvage value P27,500 x .422 11,605.00
Total Present values 637,360.00
Initial cost of investment 487,500.00
c Annual Rate of Return P51,500 / [ (487,500 + P27,500 ) / 2 ] =

P51,500 / P257,500 = 20%
9.2 Annual net income 30,000.00
Annual cash flows 78,000.00
Cost of investment 240,000.00
a Payback P240,000 / P78,000 = 3.08 years
b Total Present values P78,000 x 3.791 295,698.00

c Annual Rate of Return P30,000 / [ (240,000 + P0 ) / 2 ] =

P30,000 / P120,000 = 25%
9.3 Red Blue

Annual net income 30,000.00 50,000.00
Add, back depreciation Red: P400,000 / 8 yrs = P50,000 50,000.00
Blue : P560,000 / 8 yrs = P70,000 70,000.00
Annual cash flows 80,000.00 120,000.00
a Payback, in years Red: P400,000 / P80,000 5

Blue : P560,000 / P120,000 4.67
b Total present values Red P80,000 x 5.747 459,760.00

Blue P120,000 x 5.747 689,640.00
Initial investment cost 400,000.00 560,000.00
Net present values 59,760.00 129,640.00
c Annual rate of return Net income 1 30,000.00 50,000.00

Average investments (Cost / 2) 2 200,000.00 280,000.00
ARR (1 /2 ) 0.15 0.18
9.4 Net income 64,000.00

Depreciation 52,500.00
Net cash inflows per year 116,500.00
Present value factor at 13% for 12 years 5.9176
Total present values 689,400.40
a Net present values 59,400.40
c Payback P630,000 / P116,500 = 5.408 years
b Internal rate of return

PV Factor = P630,000 / P116,500 = 5.4077
Scanning at 12 year line , 5.4077 is approximately 15%
True rate or exact rate using interpolation is computed as follows
At 14% 5.660 5.660
PV Factor = 5.408
at 16% 5.197
0.463 0.252
Exact rate = 14% + [{.2523 / .463} x 2% ] =
14% + .01089 = 0.15089 15.089%
9.5 Cash flows
year PVF at 12% Cool Hot
Cash flows PV of cash flows Cash flows PV of cash flows
1 0.893 38,000.00 33,934.00 42,000.00 37,506.00
2 0.797 42,000.00 33,474.00 42,000.00 33,474.00
3 0.712 48,000.00 34,176.00 42,000.00 29,904.00
128,000.00 101,584.00 126,000.00 100,884.00
Cost of investments 90,000.00 90,000.00
a Net present values 11,584.00 10,884.00
PV of Hot can be computed at P42,000 x 2.402 = P100,884 also
b Profitability index = PV / Cost 1.13 1.12
c Both are acceptable, however, Cool is preferred as it has higher NPV ang PI
9.6
a Machine 1
Present values (P50,000 - P15,000) x 4.486 = 157,010.00
Cost 152,000.00
Net present values 5,010.00
Machine 2
Present values (P60,000 - P20,000) x 4.486 = 179,440.00
Cost 170,000.00
Net present values 9,440.00
b Machine 1 P157,010 / P152,000 = 1.03
Machine 2 P179,440 / P170,000 = 1.06
c IRR
Machine 1 PV Factor = P152,000 / P35,000 = 4.34 PV Factor at 6 years of 4.355 is at 10%
Machine 2 PV Factor = P170,000 / P40,000 = 4.25 PV Factor at 6 years of 4.231 is at 11%
d Both machines are acceptable

NPV both are positive
PI both are more than 1
IRR both are greater than the minimum required rate of return of 9%
9.7 a 1 Cash payback = P320,000 / P62,000 = 5.16 years
2 Present values P62.000 x 5.535 343,170.00

Net Present value 23,170.00
3 Profitability index = P343,170 / P320,000 = 1.07
4 Internal rate of return (IRR) = P320,000 / 62,000 = 5.16

5.16 for 8 years is at 11%
5 Annual rate of return (ARR) = P22,000 / [(P320,000 + 0) / 2] = 13.75%

9.8 a Based on estimates:
Present values P70,000 x 4.355 = 304,850.00
Initial costs 300,000.00
accept
b Based on actual:
Present values P58,000 x 5.759 = 334,022.00
Initial costs 340,000.00
Net present value (5,978.00)
reject
9.9 a Present value of annual cash flows = P4,300 x 5.335 22,940.50

Present value of salvage value = P3,000 x .467 1,401.00
Cost 25,000.00
Net present value negative - reject (658.50)
b Present value of annual cash flows = (P4,300 + P500) x 5.335 25,608.00

Present value of salvage value = P3,000 x .467 1,401.00
Cost 25,000.00
Net present value positive - accept 2,009.00
c Additional benefits would need to have a total present value of at least P658 in order for the van to be purchased.
9.10 a Present value of net cash flows

(P2,520,000 - P2,250,000) = P270,000 x 8.514 = 2,298,780.00
Present value of salvage value = P3,900,000 x .149 = 581,100.00
Total present values 2,879,880.00
Investment costs 2,700,000.00
b Present value of net cash flows

(P2,085,000 - P1,875,000) = P210,000 x 8.514 = 1,787,940.00
c Present value of net cash flows

(P2,520,000 - P2,250,000) = P270,000 x 7.469 = 2,016,630.00
If # of campers attending each week is only 80, NPV decreases by P510,840, that is from positive P179,880 to a
negative P330,960. Investment should not be made unless attedees is closer to 100.
9.11 a Old loss (2,000.00)
New Net income (loss) Receipts P20,000 x 5% = 1,000.00
Depreciation P12,000 / 10 years = 1,200.00
Net income (Loss) (200.00)
Net difference (1,800.00)
b Payback on the vending machine only P12,000. / P 1,000 = 12 years
relevant payback:
Payback Change in cash flow is P3,000 = salary of employee terminated
P12,000 / P3,000 = 4.00
c
1 Present value of inflows P3,000 x 4.195 = 12,577.50
Net present value 577.50
2 IRR is approximately 23%
d Present value P3,000 - (P14,000 x 5%) = 11,319.75

Cost 12,000.00
Net present value (680.25)
e Cost P12,000 / 4.1925 = P2,862.25

Receipts = (P2,862.25 - P2,000) / 5% = 17,245.00
9.12 a Revenue 100,000.00

Cash expense 60,000.00
Annual cash inflow 40,000.00
b Present value P40,000 x 4.4941 179,764.00

Cost 160,000.00
c IRR factor P160,000 / P40,000 = 4.00 approximately 23%
d Payback = P160,000 / P40,000 = 4 years 4 years
e Profitability index P179,764 / P160,000 = 1.1235
f IRR > than required

PB < than required
depends on which one will be given more weight.
9.13 a Cash payback P262,000 / P42,400 = 6.1792
b IRR at 12 years 6.1793 is approximately 12% 12%
c Present value P42,400 x 6.8137 = 288,900.88

Cost 262,000.00
d yes, acceptable
9.14
1 Use table PV of Ordinary Annuity of P1
P200,000 = Annual Payments x the factor at interest rate at 30 years
a AP = P200,000 / 11.2578 17,765.46
b AP = P200,000 / 9.4269 21,215.88
c AP = P200,000 / 8.0552 24,828.68
2 P200,000 = Annual Payments x the factor at interest rate at 15 years

a AP = P200,000 / 8.5595 23,365.85
b AP = P200,000 / 7.6061 26,294.68
c AP = P200,000 / 6.8109 29,364.69
3 a Total payments = 30 x P21,216 = 636,480.00

Total interest paid P636,480-200,000 436,480.00
b Total payments = 15 x P26295 = 394,425.00

Total interest paid P394,425 - 200,000 194,425.00
9.15 a Use table PV of P1

PV of P1 at 12% for 5 years is .5674 The P500 million is the future amount
PV = P500,000,000 x .5674 = 283,700,000.00
b Use table PV of Ordinary annuity of P1. The P100 million is a uniform periodic payment at the
end of series of years. Therefore it is an annuity.
PV of Annuity = P100,000,000 x 3.6048 = 360,480,000.00
In particular, note that Prudential is willing to lend more than in No. 1 even though the interest rate
is the same. Because the company will get its money back more quickly.
9.16 a PV = P30,000 x .6302 18,906.00
b PV = P30,000 x ..4104 12,312.00
c Halves the rates and double the number of periods. Present values decline:
PV = P30,000 x .6246 18,738.00
9.17
a P80,000 = Future amount x .3050 FA = P80,000 / .3050 262,295.08
b P80,000 = Future annual amount x 4.3436 FAA = P80,000 / 4.3436 18,417.90
9.18 List price 42,000.00

Less, Trade in allowance (9,000.00)
Initial cash outlay 33,000.00
Present value of cash operating savings, from 12 year,
PV of ordinary annuity at 12% = P5,000 x 6.1944 30,972.00
Net present value - NPV is negative, do not buy (2,028.00)
The trade-allowance really consists of a P3,000 adjustment of the selling price and a bonafide
P6,000 cash allowance for the old equipment. The relevant amount is the incremental cash outlay
of P33,000. The book value is irrelevant.
9.19 The quickest solution is to get the "net" inflows for each year:
1 End of year Inflows Outflows net flows
1 200,000.00 150,000.00 50,000.00
2 250,000.00 200,000.00 50,000.00
3 300,000.00 250,000.00 50,000.00
4 400,000.00 300,000.00 100,000.00
5 450,000.00 350,000.00 100,000.00
3 payments P50,000 x 2.3216 116,080.00

2 payments P100,000 x 1.6467 x .6750 111,152.25
less, initial investment 210,000.00
2 The IRR is more than 14%, because the NPV is positive.
9.20 a initial net cash inflows

year investments each year cumulative
0 60,000.00 - (60,000.00)
1 28,000.00 (32,000.00)
2 26,000.00 (6,000.00)
3 24,000.00 18,000.00
Payback period = 2 + ( P6,000 / P 24,000) = 2 + .25 = 2.25 years

b Net present value
net cash inflows PV Factor
year each year at 12% Present value
0 - - (60,000.00)
1 28,000.00 0.8929 25,001.20
2 26,000.00 0.7972 20,727.20
3 24,000.00 0.7118 17,083.20
net present value 2,811.60
c at a 12% rate, NPV is positive, Therefore, to get an exact IRR, try a higher rate then interpolate.
inflow 14% factor PV at 16% factor PV

28,000.00 0.8772 24,561.60 0.8621 24,138.80
26,000.00 0.7695 20,007.00 0.7432 19,323.20
24,000.00 0.6750 16,200.00 0.6407 15,376.80
60,768.60 58,838.80
initial investment 60,000.00 60,000.00
net present value 768.60 (1,161.20)
at 14% 60,769.00 60,769.00

true rate 60,000.00
at 16% 58,839.00
1,930.00 769.00
True rate = 14% + (769 / 1,930) x 2% = 14% + .8% = 14.8%
d Depreciation per year P60,000 / 3 years = P20,000

Expected Savings in annual operating costs (average)
(P28,000 + P26,000 + P24,000) / 3 = P26,000
(a) ARR on initial investment = (P26,000 - P20,000 ) / P60,000 = 10.00%

(b) ARR on average investment = (P26,000 - P20,000 ) / P30,000 = 20.00%
9.21
Old machine:
Operating cash outflows P50,000 x 3.00 (150,000.00)
Investment in inventories - outflows P200,000 x 1 (200,000.00)
Liquidation value of inventories at terminal date P200,000 x .40 80,000.00
Disposal value of machine * P4,000 x .40 1,600.00
(268,400.00)
New machine
Net cash outlay (P62,000-P15,000) P47,000 x 1.00 (47,000.00)
Operating cash outflows P40,000 x 3 (120,000.00)
Investment in inventories - outflows P160,000 x 1 (160,000.00)
Liquidation value of inventories at terminal date P160,000 x .40 64,000.00
Disposal value of machine * P4,000 x .40 1,600.00
(261,400.00)
PV in favor of new machine - minimizes the PV of future costs 7,000.00
* could be excluded from both alternatives as they have the same amounts - irrelevant cost
Using the incremental cost analysis approach:
Net cash outlay (P62,000 - P15,000) P47,000 x 1 (47,000.00)
Liquidation value of inventory at time zero P40,000 x 1 40,000.00
Difference in recovery of cash from inventory
liquidation value at terminal date P40,000 x .40 (16,000.00)
Operating savings (P50,000 - P40,000) P10,000 x 3 30,000.00
Net present value in favor of new machine 7,000.00
9.22 Alternative 1 Alternative 2

1 Amount invested 10,000.00 10,000.00
Total increase in cash flows:
Year 0 - 5 P2,000 x 5; P1,500 x 5 10,000.00 7,500.00
Years 6 - 10 P1,000 x 5; P1,500 x 5 5,000.00 7,500.00
totals 15,000.00 15,000.00
Average annual cash flow 1,500.00 1,500.00
Less, Depreciation or amortizations P10,000 / 10 years 1,000.00 1,000.00
Average annual net income 500.00 500.00
ARR on original investments 0.05 0.05
2 IRR Alternative 1 could also be interpreted at cash inflows received at P1,000 for the next 10 years
plus P1,000 for the first 5 years.
P10,000 = PV pf P1,000 at X% for 10 years + PV of P1,000 at X% for the first 5 years.
Let F1 = be the value of X% for 10 years and F2 be the value of X% for 5 years
P10,000 = P1,000 (F1) + P1,000(F2)
P10,000 = P1,000 ( F1 + F2)
F1 + F2 = P10,000 / P1,000 = 10
F1 at 8% for 10 years = 6.7101 F2 at 8% for 5 years = 3.9927
F1 at 10% for 10 years = 6.1446 F2 at 10% for 5 years = 3.7908
at 8% (P1,000 x 6.7101) + (P1,000 x 3.9927) = P10,703
at 10% (P1,000 x 6.1446) + (P1,000 x 3.7908) = P9,935
in rate (F1 + F2) in pesos in rate (F1 + F2) in peso

at 8% 10.7028 10,703.00 10.7028 10,703.00
true rate - - 10.0000 10,000.00
at 10% 9.9354 9,935.00 - -
0.7674 768.00 0.7028 703.00
Exact rate = 8% + (.7028 /.7674) x 2% = 8% +1.83% = 9.83%
Alternative 2
P10,000 = PV pf P1,500 at X% for 10 years
P10,000 = P1,500 (F)
F = P10,000 / P1,500 = 6.6667
At 8% F = 6.7101 6.7101 6.7101
true rate 6.6667
At 10%, F = 6.1446 6.1446
0.5655 0.0434
True rate = 8% + (.0434 / .5655) x 2% = 8% + .15% = 8.15%
3 The difference between the 9.83% return on Alternative 1 and the 8.15% return on alternative 2 is from the
fact that under Alt. 1, there are greater cash inflows during the first 5 years than under Alt. 2. Under the
Discounted Cash Flow (DCF) method, early cash inflows are weighted more heavily than inflows of later
years since this method considers the time value of money.
9.23
1 PV of annual cash inflows P50,000 x 3.8887 194,435.00
PV of salvage value of machine at end of 6 years P22,000 x .4556 10,023.20
PV of salvage value of parts at end of 6 years P15,000 x .4556 6,834.00
Initial investments 202,000.00
2 IRR IRR will be greater than 14% because the net present value is positive, try 16%
PV of annual cash inflows P50,000 x 3.6847 184,235.00
PV of salvage value of machine at end of 6 years P22,000 x .4104 9,028.80
PV of salvage value of parts at end of 6 years P15,000 x .4104 6,156.00
Initial investments 202,000.00
Net present value negative (2,580.20)
Therefore, the IRR is just below 16%
3 ARR
a Average annual income 50,000.00
Less, Depreciation (P187,000 - P22,000) / 6 years 27,500.00
Net annual income 22,500.00
Initial investment (P187,000 + P15,000) 202,000.00
ARR on initial investment 11.14%
b Average annual income 50,000.00

Less, Depreciation (P187,000 - P22,000) / 6 years 27,500.00
Net annual income 22,500.00
Average investment (P202,000 + P22,000 +P15,000) / 2 = P119,500 119,500.00
ARR on average investment 18.83%
4 The models in requirements 1 and 2 would give a positive decision.

However, the 11.14% ARR based on initial investment might give a negative decision because it is less
than 14%.
9.24 1 Total PV
Cash effects of operation (P150,000 x .60% net of tax) P90,000 x 2.2459 202,131.00
Savings on income taxes on deprn. (P100,000 x .40) P40,000 x 2.2459 89,836.00
Total after tax effect on cash 291,967.00
Investments (300,000.00)
Net present value, negative (8,033.00)
The computers should not be acquired.
2 After tax impact of disposal on cash P.60 (P40,000 - 0) = P24,000

PV is P24,000 x .6407 15,376.80
Net present value in (1) (8,033.00)
New net present value , positive 7,343.80
The computers should be acquired.
3 Applying a 12% discount factor

P150,000 (1 -.40) x 2.4018 = P90,000 x 2.4018 216,162.00
P100,000 x .40 x 2.4018 P40,000 x 2.4018 96,072.00
Investments (300,000.00)
Net present value, positive, therefore acquire 12,234.00
9.25
Sales 520.00
less, expenses excluding depreciation 350.00
Depreciation 100.00
Total expenses 450.00
Income before income taxes 70.00
Income taxes at 40% 28.00
Net income 42.00
Cash effects of operations:
Cash inflows from operations less cash expenses P520 -350 170.00
Less, Income tax outflow without depreciation ( P170 x .40) 68.00
102.00
Effect on deprection as savings on income tax
Depreciation P100 x .40% 40.00
Total after tax effect on cash 142.00
Total after tax effect on cash is

Cash inflows from sales 520.00
Cash outflows for expenses (350.00)
Cash outflows for tax (28.00)
Total after tax cash received. 142.00
9.26 Investment (45,000.00)
Cash operating savings
Annual savings 13,500.00
Income taxes at 40% P13,500 x 40% 5,400.00
After tax effect on cash 8,100.00
Present value (P8,100 x 4.5638) 36,966.78
PV of tax savings from depreciation:
Investment x PV Factor x tax rate P45,000 x .7809 x .40 14,056.20
Overhaul requirement:
Total cost 5,000.00
Less, income tax savings at 40% 2,000.00
Total after tax effect 3,000.00
Present value (P3,000 x .6355) (1,906.50)
Residual value
Cash received 4,000.00
Book value -
Gain 4,000.00
Income tax effect on gain at 40% 1,600.00
Total after tax effect 2,400.00
Present value (P2,400 x .4523) 1,085.52
Net present value of all cash flows 5,202.00
The investment is desirable
9.27
1 New machine 120,000.00
Disposal value of old machine (20,000.00)
Incremental tax on gain on disposal (P20,000 - P16,000) x 35% 1,400.00
Net cost of investment 101,400.00
2 Savings before taxes 40,000.00

Less, Income tax
Net cash flow before tax 40,000.00
Less depreciation expense
(P120,000 - 16,000)/10 years (10,400.00)
Net income subject to tax 29,600.00
tax rate 0.35 (10,360.00)
Net cash flows after tax 29,640.00
9.28
1 Net income before depreciation 12,000.00
Less Depreciation expense (P60,000 / 10 years) (6,000.00)
Net income after depreciation 6,000.00
Less Income tax (P6,000 x .35) (2,100.00)
2 Accounting Rate of Return (ARR) (P3,900 / 60,000) 6.5%

3 Cash flow before taxes 12,000.00
Less income tax (P6,000 x .35) (2,100.00)
Net cash flow after taxes 9,900.00
4 Payback period P60,000 / 9,900 in years 6.06
5 Payback reciprocal P9,900 /60,000 in percentage 16.50%

or it can be computed by dividing 1 with the payback period
1 / 6.06 16.50%
9.29
Purchase price 100,000.00
Start up costs 3,000.00
Trade in value of fold machine (15,000.00)
Salvage values of other assets (6,000.00)
Tax savings on loss on retirement (800.00)
Repair cost saved (8,000.00)
Additional working capital 24,000.00
Net initial cost of investment 97,200.00
9.30 tax computation cash flows

1 Sales (10,000 x P15) 150,000.00 150,000.00
Variable costs (10,000 x P8) (80,000.00) (80,000.00)
Contribution margin (10,000 x P7) 70,000.00 70,000.00
Fixed operating costs (25,000.00) (25,000.00)
Cash flows before taxes 45,000.00 45,000.00
Depreciation expense (P100,000 / 5 years) (20,000.00) -
Incremental net income before taxes 25,000.00 45,000.00
Income tax at 32% (8,000.00) (8,000.00)
Increase in net income 17,000.00
Add back, depreciation expense 20,000.00
NET CASH INFLOW PER YEAR 37,000.00 37,000.00
2 Net cash inflow per year 37,000.00

Present value factor, 5 years annuity at 14% (Table II) 3.433
Present value of future net cash flows 127,021.00
Less Investment 100,000.00
3 Payback period
Net investment cost a 100,000.00
Net annual cash inflows b 37,000.00
Payback period (a / b) 2.7027
4 Internal rate of return IRR
Them IRR is over 24.75%.
The factor is to be determined using the payback period which2.703
Because 2.7027, the closest factor in the five-year row of Table II is 2.745 at 24% and 2.689 at 25%.
(Remember, the higher the rate, the lower the factor.)
Get interest rates where the factor is in between.
To determine the exact or true rate:
At 24% Present value of P1 in annuity 2.745 2.745

Payback factor 2.703
At 25% 2.689
Difference 0.056 0.042
Exact rate [24% + (.042/.056) x 1%] 0.2475
5 The book rate or accounting rate of return
Net income after tax a 17,000.00
Average investment b 50,000.00
P100,000 / 2
Rate of return (a / b) 0.34
6 The only change required is the determination of the present value of the salvage value
less the tax on the gain.
Salvage value 5,000.00

Tax rate at 32% (P5,000 x 32%) 1,600.00
net cash inflow, end of year 5 3,400.00
Present value factor for single payment 5 years at 14%
in table I 0.519
Present value of salvage value 1,764.60
Add, net present value from number 2 27,021.00
NET PRESENT VALUE 28,785.60
NOTE: We did not have to recompute annual net cash flows. The company still used P20,000 for
Depreciation expense, therefore at end of year 5, the book value is zero and there will be
a gain equal to the salvage value.
9.31
annual net cost of internal rate Net present
Cases cash inflows investments capital of return value
A 120,000.00 503,040.00 14% 20% 122,892.00

B 180,000.00 808,938.00 12% 18% 208,062.00
C 124,141.00 600,000.00 10% 16% 162,880.00
D 200,000.00 900,000.00 12% 18% 230,000.00
CASE A 1 Internal rate of return (IRR)

Investment a 503,040.00
Annual net cash inflows b 120,000.00
Payback factor ( at 10 periods interest of 20%) (a / b) 4.1920
2 Net present value

PV of cash inflows (14% for 10 years) (P120,000 x 5.2162) 625,932.00
PV of investments (503,040.00)
CASE B 1 Investment
Annual net cash inflows a 180,000.00
PV factor at 18% for 10 years b 4.4941
Present value of net cash inflows ( a x b) 808,938.00
2 Net present value

Net present value of cash inflows at 12% for 10 years
(P180,000 x 5.65 ) 1,017,000.00
Present value of investments (808,938.00)
CASE C 1 Annual net cash inflow
Investment a 600,000.00
PV factor (16% for 10 years) b 4.8332
Annual net cash inflow (a / b) 124,141.36
2 Cost of capital
Investment 600,000.00
Total PV of cash inflows a 762,880.00
Annual net cah inflow b 124,141.36
Present value factor (which at 10% for 10 years) (a /b) 6.14525
nearest is 6.1446
CASE D 1 Annual net cash inflow

Total PV of cash inflows a 1,130,000.00
PV factor at 12% for 10 years b 5.65
Annual net cash inflow (a / b ) 200,000.00
9.32
1 Annual profit net of tax
Process 1 Process 2
Sales ( 100,000 @ P50) 5,000,000.00 5,000,000.00
Less, Variable costs at P20 and at P10 (2,000,000.00) (1,000,000.00)
Contribution margin 3,000,000.00 4,000,000.00
Less, Variable
Fixes
costs
costs:
at P20 and at P10
Cash fixed costs 400,000.00 600,000.00
* Depreciation expense on the investment for 4 yrs. 1,000,000.00 1,500,000.00
Total 1,400,000.00 2,100,000.00
Net income before income tax 1,600,000.00 1,900,000.00
Income tax at the rate of 32% (512,000.00) (608,000.00)
Net income after tax 1,088,000.00 1,292,000.00
* Cost of investment / 4 years
2 Accounting rate of return on average investments

Net income after tax a 1,088,000.00 1,292,000.00
Average investments (investment / 2) b 2,000,000.00 3,000,000.00
ARR (a / b) 0.5440 0.4307
OR 54.40% 43.07%
3 Net income after tax (see solution in no. 1) 1,088,000.00 1,292,000.00
Add back, depreciation expense 1,000,000.00 1,500,000.00
Annual cash inflows after tax a 2,088,000.00 2,792,000.00
PV factor at 16% for 4 years b 2.7980 2.7980
Present value of annual cash inflows c =(a x b) 5,842,224.00 7,812,016.00
PV of investment d 4,000,000.00 6,000,000.00
Net present value (c - d) 1,842,224.00 1,812,016.00
4 Payback period
Investment a 4,000,000.00 6,000,000.00
Annual cash inflow b 2,088,000.00 2,792,000.00
Payback period (a / b) 1.92 2.15
5 Recommendation:
Net income 1,088,000.00 1,292,000.00
ARR 0.544 0.431
Net present value 1,842,224.00 1,812,016.00
Payback 1.92 2.15
Comparing the different measures, it seems that Process I has more advantanges over
Process 2, so most likely it would be Process I. However, the management
must also consider the effects of qualitative issues that could be associated to the
two processes.
9.33
a Cost of new equipment 175,000.00
Cost of removing old equipment 5,000.00
Resale value of old equipment (40,000.00)
Net cost of investment 140,000.00
b Net present value before taxes

Annual operating costs -old equipment (P30,000-+ P48,000) 78,000.00
Annual operating costs -new equipment (P25,000+ P20,000) (45,000.00)
Annual operating cost savings before taxes 33,000.00
Present value of Savings (P33,000 x 5.019) 165,627.00

Net initial cost of investment (140,000.00)
Net Present value 25,627.00
c The investment should be made since the NPV has a positive results.
9.34 Analysis of Cash Flows
PRESENT PROPOSED DIFFERENCE
Revenue 200,000.00 15,000.00 *
Expenses:
Miscellaneous 100,000.00 -
Salaries 110,000.00 13,000.00
210,000.00 13,000.00
Net cash flows (10,000.00) 2,000.00 (12,000.00)
Required Investment:
Equipment - 19,000.00 **
Termination pay - 28,000.00
- 47,000.00 (47,000.00)
* 10% x P150,000 = P15,000 comission
**An acceptable alternative would be to show P3,000 and P22,000 resprectively. The incremental investment
would still be P19,000.
a Present value of P12,000 per year for 10 years at P12,000 x 6.000 72,000.00
Required investment 47,000.00
The requirements of the problem focus on the incremental approach. The total project apporach could
view the problem as choosing the alternative that minimizes the net present value of the future costs:
Present:
Operating cash outflows, P10,000 x 6.00 (60,000.00)
Proposed:
Operating cash inflows, P2,000 x 6.00 12,000.00
Termination pay (28,000.00)
Equipment (19,000.00)
Total (35,000.00)
Difference in favor of proposed investment 25,000.00
b The minimum amount of annual revenue that the company would have to receive to justify the
investment would be theat amount yielding an incremental net present value of zero. As the initial
investment is constant, any change in the incremental net present value is due solely to a change in the
amount of revenue. Therefore, the maximum drop in the incremental net present value of P25,000 equals
the maximum drop in the present value of the revenue stream. This implies a maximum drop of
P25,000 / 6 = P4,167 in annual revenue and a minimum amount of annual revenue of P15,000 - P4,167 =
P10,833
Let X = Revenue at point of indifference, where net present value is zero

NPV = PV (New annual cash flows - old annual cash flfows) - Required investment
0 = 6.00[(X - 13,000) - (-10,000)] - 47,000
0 = 6.00(X -13,000 + 10,000) - 47,000
0 = 6.00(X- 3,000) - 47,000
0 = 6.00X - 18,000 - 47,000
6.00X = 65,000
X = 10,833
Part 2 demonstrates sensitivity analysis, where the manager may see the potential impact of the
possible errors in the forecasts of revenue. Such analysis shows how much of a margin of safety is
available. In this case, his "best guess" is revenue of P15,000 ( in part 1). Sensitivity analysis shows
him that a decline of revenue would have to occur from P15,000 to P10,833 before the rate of return on the
project would decline to the minimum acceptable level.
Another approach to solve requirement 2 could be:
If 10% is the minimum acceptable rate of return, the minimum acceptable net present value must
be zero, using the 10% rate:
NPV = PV if future cash flows - initial investment
Let X = Annual cash inflow
Then 0 = 6.00(X) - 47,000
X = P47,000 / 6.00
X = P7,833
Present value of P7.833 per year for 10 years at 10% P7,833 x 6.00 47,000.00
Required investment 47,000.00
Net present value (0.00)
Note that the requirement asks for the minimum amount of revenue, as distinguished from the difference
in cash flows.
The following analysis shows that revenue can fall toP10,833. Note also that there can be negative
cash flows under both alternatives; the alternative with the least negative cash flow is preferable
Present Proposed Diff. in cash flows

Revenues 200,000.00 10,833.00
Expenses 210,000.00 13,000.00
Net cash flow from operations (10,000.00) (2,167.00) (7,833.00)
9.35
1 Payback period P200,000 / P40,000 5 years
2 Present value of cash inflow at 10% for 8 years P40,000 x 5.335 213,400.00
3 Yes Assuming that the only criteria is the NPV because it has a positive NPV
9.36
a P1,000 is being compounded for 3 years, so your balance on January 1, 2011 is P1,259.71
longway
a b c d e
(bxc) ( b + d)
end of beginning interest interest ending
year balance rate amount balance
2009 1,000.00 0.08 80.00 1,080.00
2010 1,080.00 0.08 86.40 1,166.40
2011 1,166.40 0.08 93.31 1,259.71
shortcut formula
FV = PV(1 + k )4 P1,000(1 + .08)4 = P1,259.71
b The effective annual rate for 8 percent, compunded quarterly
longway
a b c d e
(bxc) ( b + d)
end of beginning interest interest ending
year balance rate amount balance
2009-1st 1,000.00 0.02 20.00 1,020.00
2nd 1,020.00 0.02 20.40 1,040.40
3rd 1,040.40 0.02 20.81 1,061.21
4th 1,061.21 0.02 21.22 1,082.43
2010- 1st 1,082.43 0.02 21.65 1,104.08
2nd 1,104.08 0.02 22.08 1,126.16
3rd 1,126.16 0.02 22.52 1,148.69
4th 1,148.69 0.02 22.97 1,171.66
2011-1st 1,171.66 0.02 23.43 1,195.09
2nd 1,195.09 0.02 23.90 1,218.99
3rd 1,218.99 0.02 24.38 1,243.37
4th 1,243.37 0.02 24.87 1,268.24
shortcut
use FV for % at 12 periods (4 quarters is x 3 years)
FV = P1,000(1.2682) = P1,268.20
c as you solve this problem, keep in mind that the tables assume that payments are made at the end
of each period. Therefore, you may solve this prblem by finding the future value of an annuity of P250
for 4 years at 8 percent.
longway
a b c d e
(bxc) ( b + d)
beginning beginning additional interest interest ending
of year balance investment rate amount balance
2008 250.00 0.08 20.00 270.00
2009 270.00 250.00 0.08 41.60 561.60
2010 561.60 250.00 0.08 64.93 876.53
2011 876.53 250.00 1,126.53
shortcut
FV = P250(4.5061) = P1,126.53
FV of annuity of P250 for 4 years at 8 percent is 4.5061
d An amount is deposited in 4 equal payments in the account at 8% interest rate to obtain balance similar to the amount
equal to requirement letter a (P1,259.71)
longway
a b c d e
(bxc) ( b + d)
beginning beginning additional interest interest ending
of year balance investment rate amount balance
2008 279.56 0.08 22.36 301.92
2009 301.92 279.56 0.08 46.52 628.00
2010 628.00 279.56 0.08 72.61 980.17
2011 980.17 279.56 1,259.73
shortcut formula
P1,259.71 = Amount(4.5061)
Amount = P1,259.71 / 4.5061
= 279.56
9.37
a Alternative a - Investment in the Project
1 2 3 (1 +2 ) 4 5 (3 - 4)
Loan balance Interest at Accumulated Cash for Loan Balance
beginning of 10% per amount at Repayment at end of
Year the year year End of year of loan Year
0 -
1 100,000.00 10,000.00 110,000.00 45,000.00 65,000.00
2 65,000.00 6,500.00 71,500.00 45,000.00 26,500.00
3 26,500.00 2,650.00 29,150.00 45,000.00 (15,850.00)
* Cash of P45,000 is available to pay P29,150 total accumulated loan balance.
b Alternative b - Keep cash and invest in time deposit

1 2 3 (1 +2 )
Investment Interest at Accumulated
balance at 10% per amount at
beginning at
Year of year year End of year
0 - -
1 11,915.00 1,191.50 13,106.50
2 13,106.50 1,310.65 14,417.15
3 14,417.15 1,441.72 15,858.87
* Net present value computation:
PV of annual cash inflows for 3 periods at 10% (P45,000 x 2.487) 111,915.00
Present value of investments 100,000.00
Net present value to be used as the initial investment (see year 1) 11,915.00
Chapter 10
Long Term Financing Decision - Key
I TRUE OR FALSE

5 FALSE 20 FALSE 35 FALSE
8 FALSE 23 TRUE 38 TRUE
11 TRUE 26 TRUE
12 FALSE 27 TRUE
13 FALSE 28 TRUE
14 FALSE 29 TRUE
15 TRUE 30 FALSE
II MULTIPLE CHOICES QUESTIONS

1 d 12 a 23 d 23 d 34 c
2 c 13 b 24 c 24 c 35 a
3 c 14 b 25 d 25 d 36 c
4 a 15 a 26 c 26 c 37 d
5 c 16 c 27 d 27 d 38 b
6 d 17 a 28 a 28 a 39 c
7 b 18 c 29 b 29 b 40 d
8 a 19 d 30 a 30 a 41 a
9 d 20 b 31 a 31 a
10 d 21 d 32 a 32 a
11 b 22 c 33 b 33 b
III MULTIPLE CHOICES PROBLEMS
1 d 11 b
2 d 12 d
3 a 13 a
4 d 14 c
5 b 15 b
6 c 16 d
7 b 17 b
8 d 18 d
9 a 19 c
10 c 20 a
10.1 Expected Sales 1,000,000.00
Miscellaneous Income 100,000.00
Total Gross Income 1,100,000.00
Less, Disbursements:
Wages Expenses 300,000.00
Raw materials 400,000.00
Other expenses 100,000.00
Total 800,000.00
Net income (net cash inflows) 300,000.00
Add, Beginning cash balance 150,000.00
Total 450,000.00
Less, Required minimum cash balance 100,000.00
Available cash balance or net income for interest payments on planned loan 350,000.00
Maximum loanable amount = P350,000 0.07
/ interest rate = 5,000,000.00
10.2
a Breakeven point in units = FC / CM per unit =
P90,000 / (P132 - P80) = 1,730.77
b Breakeven point in persos = P132 x 1,731 = 228,492.00
c Net income at sales levels of 2,000 10,000

Sales at P132 per unit 264,000.00 1,320,000.00
Variable costs at P80 per unit 160,000.00 800,000.00
Fixed costs 90,000.00 90,000.00
Net income 14,000.00 430,000.00
d Degree of operating leverage

/ Net income 14,000.00 430,000.00
DOL 7.43 1.21
10.3 Net income using the Return on operating assets:

ROA = Net income / Operating assets
12 % = NI / P1,000,000 = P1,000,000 x .12 = 120,000.00
Sales using the asset turnover:

ATO = Sales / Operating assets = Sales / P1,000,000 = 4
Sales = P1,000,000 x 4 = 4,000,000.00
DOL (at 75,000 units) = Sales - Variable cost or EBIT before fixed costs or CM
EBIT
6 = Contribution margin / P120,000 = P720,000
Variable costs = P4,000,000 - P720,000 = P3,280,000
Sales at 75,000 units at P53.33 per unit 4,000,000.00

Variable costs at 75,000 units at P43.73 per unit 3,280,000.00
Contribution margin P53.33 - 43.73 = P9.60 cm per unit 720,000.00
Fixed costs 600,000.00
BREAKEVEN POINT IN UNITS = P600,000 / P9.60 per unit = 62,500.00
10.4 Sales 3,000,000.00
Multiplied by Contribution margin ratio 0.60
Contribution margin or Revenue before fixed costs 1,800,000.00
Less, EBIT * 900,000.00
Fixed costs 900,000.00
*EBIT = Revenue before fixed costs / DOL

= P1,800,000 / 2 = 900,000.00
DCL = DOL x DFL

DFL = DCL / DOL DFL = 3 / 2 = 1.5
DFL = EBIT / (EBIT - I) I = EBIT - (EBIT / DFL)

I = P900,000 - (P900,000 / 1.50) = 300,000.00
10.5
a Market value of the firm =
V = P30 x 1,000,000 shares = 30,000,000.00
b Cost of common equity = P6,000,000 / P30,000,000 = 0.20
c EBIT 6,000,000.00
Less, Interest expense (P9,000,000 x 8%) 720,000.00
Earnings available to common (EAC) 5,280,000.00
At P30 per share, 300,000 shares could be retired using P9,000,000 proceeds from debt, leaving 700,000 shares.
New EPS = P5,280,000 / 700,000 shares = 7.543
Market price per share = P7.54 / 20% = 37.715
New market value of the firm = Market value of S + Market value of Debt
Market value of Stock = P37.71 x 700,000 shares = 26,397,000.00
Market value of Debt = 9,000,000.00
Total market value of the firm 35,397,000.00
1 Cost of equity after refinancing = P5,280,000 / P26,397,000 = 0.20

2 Cost of capital after refinancing = P6,000,000 / P35,397,000 = 0.17
10.6
a EPS if stock is issued:
new shares to be issued P4,000,000 / P60 = 66,666.67 shares
[(EBIT - P480,000)(1.-.46) - P10,000] / (350,000 + 66,667)
EPS if bond is issued:

[(EBIT - P960,000)(1.-.46) - P10,000] / (350,000)
Indifference point =
[(EBIT - P480,000)(1.-.46) - P10,000] / (350,000 + 66,667) = [(EBIT - P960,000)(1.-.46) - P10,000] / (350,000)
EBIT = P3,493,889 if at indifference point

issue issue issue issue
b stock bond stock bond
EBIT 3,000,000.00 3,000,000.00 3,493,889.00 3,493,889.00
Less, Interest expense 480,000.00 960,000.00 480,000.00 960,000.00
Earnings after interest expense 2,520,000.00 2,040,000.00 3,013,889.00 2,533,889.00
Less, Income tax expense at 46% 1,159,200.00 938,400.00 1,386,388.94 1,165,588.94
Net income after tax 1,360,800.00 1,101,600.00 1,627,500.06 1,368,300.06
Less, Preferred dividends 10,000.00 10,000.00 10,000.00 10,000.00
Earnings available to common 1,350,800.00 1,091,600.00 1,617,500.06 1,358,300.06
Common shares 416,667 350,000 416,667 350,000
EPS 3.24 3.12 3.88 3.88
10.7
a Total fixed financing charges:

Interest expense P4,000,000 x 10% = 400,000.00
Bond sinking fund amortization 200,000.00
600,000.00
b Cash collections 4,500,000.00

Miscellaneous receipts 600,000.00
Total 5,100,000.00
Less, Outflows:
Wages and salaries 1,500,000.00
Raw materials costs 2,000,000.00
Non discretionary costs 800,000.00
4,300,000.00
Cash balance 800,000.00
Add, cash balance beginning 800,000.00
Totals 1,600,000.00
Less, fixed financing charges 600,000.00
Cash balance ending 1,000,000.00
Total cash balance ending = P800,000 + P800,000 +P4,000,000 - P600,000 = 4,200,000.00
c Cash balance ending before the bond proceeds showed that the fixed financing charges of P600,000
could cover its fixed cash obligations if bonds are issued.
10.8 EBIT 114,000.00
Add, Fixed costs 133,200.00
Contribution margin 247,200.00
Divide by the contribution margin ratio 0.60
Total sales 412,000.00
Expected units of production and sales 66,000
Selling price per unit 6.24
10.9 Electrical Chemical Food Total

a Sales 8,000,000.00 8,000,000.00 8,000,000.00 24,000,000.00
CMR 0.10 0.25 0.65
Variable costs ratio 0.90 0.75 0.35
Variable costs 7,200,000.00 6,000,000.00 2,800,000.00 16,000,000.00
Contribution margin 800,000.00 2,000,000.00 5,200,000.00 8,000,000.00
Fixed costs 5,500,000.00
Net income 2,500,000.00
Product sales mix CMR WCMR BEP

Electrical 0.3333 10% 0.033 5,504,954.95
Chemical 0.3333 25% 0.083 5,504,954.95
Food 0.3333 65% 0.217 5,504,954.95
0.333 16,514,864.86
Total BEP Sales = FC / WCMR = P5,500,000 / .333 = 16,516,516.52
10.10
a Degree of operating leverage = Revenue before fixed costs / EBIT
= P600,000 / P250,000 = 2.40 times
b Degree of financial leverage = EBIT / EBIT - Interest = P250,000 / (P250,000 - P100,000) =

= P250,000 / P150,000 = 1.67 times
c Degree of combined leverage = DOL x DFL = 2.40 x 1.67 = 4.01
10.11
a Sales P2,200,000 / P8 selling price = 275,000 units 2,200,000.00 2,200,000.00
Variable costs P2.40 x 275,000 = 660,000.00 660,000.00
Contribution margin 1,540,000.00 1,540,000.00
Less, Net income before tax P150,000 / .66 227,272.73 1,312,727.27
Fixed costs 1,312,727.27 227,272.73
income tax 77,272.73
b BEP in units = P1,312,727.27 / (P8.00 - 2.40) 234,415.58

10.12
a [(EBIT)(1-.40)] / 1,500,000 = [(EBIT - P900,000)(1. - 40)] / 1,000,000
EBIT = P2,700,000
b The bond plan will magnify changes in EPS since it increases financial leverage
c Since P3.1million EBIT is above the indifference point of P2.7 million, the bond plan will give a higher EPS.
Chapter 11
Risks and Rates of Returns - Key
True or False
1. True
2. False
3. False
4. False
5. False
6. True
7. True
8. False
9. False
10. True
11. False
12. True
13. False
14. True
15. True
16. False
17. True
18. False
19. False
20. False
21. True
22. False
23. True
24. True
25. True
26. False
27. False
28. True
29. False
30. True
MC Theories
1. A
2. B
3. D
4. B
5. C
6. B
7. C
8. C
9. C
10. C
11. A
12. D
13. A
14. B
15. C
16. A
17. D
18. A
19. C
20. A
21. B
22. B
23. D
24. C
25. A
26. D
27. A
28. C
29. B
30. A
MC Problems
1. B
(2.3) Portfolio beta
1.2 = (1/20)(0.7) + (19/20)b
b is average beta for other 19 stocks
1.165 = (19/20)b
b = 1.2263
To compute for new beta

b = 1.2263*(19/20) + 1.4*(1/20)
b = 1.235
2. D
$100,000 $150,000 $50,000
bp = (0.8) + (1.2) + (1.8)
$300,000 $300,000 $300,000
bp = 1.167
Last year: r = 13%
13% = 7% + RPM(1.167)
6% = RPM(1.167)
RPM = 5.1429%
This year:
r = 7% +(5.1429% + 2%)1.167
r = 15.33%
3. D
Rise Y 22 - 16 6
b= = = = = 1.5
Run X 15 - 11 4
rs = 15% = 9% + (rM - 9%)1.5

6% = (rM - 9%)1.5
4% = rM - 9%
rM = 13%
4. C
röJ = (0.2)(0.10) + (0.6)(0.15) + (0.2)(0.20) = 0.15 = 15.0%
Expected return = 15.0%
 2J = (0.2)(0.10 - 0.15)2 + 0.6(0.15 - 0.15)2 + (0.2)(0.20 - 0.15)2 = 0.001
Standard deviation = 0.001
= 0.0316
= 3.16%
5. C
CV = Standard deviation/Expected return
Expected return = 0.1(-60%) + 0.2(-10%) + 0.4(15%) + 0.2(40%) + 0.1(90%)
= 15%
= [0.1(-60% - 15%)2 + 0.2(-10% - 15%)2 + 0.4(15% -15%)2
+ 0.2(40% - 15%)2 + 0.1(90% - 15%)2]^(1/2)
= 1,375^(1/2)
= 37.081%
CV = 37.081%/15% = 2.4721
6. D
rRF = r* + IP = 3% + 5% = 8%
rs = 8% + (5%)2.0 = 18%
7. D
12.25% = 5% + (RPM)1.15
7.25% = (RPM)1.15
RPM = 6.30%
8. B
röp = 0.9(12%) + 0.1(20%) = 12.8%
bP = 0.9(1.2) + 0.1(2.0) = 1.28
9. A
The portfolio’s beta is a weighted average of the individual security betas as follows:
(P50,000/P75,000)1.5 + (P25,000/P75,000)0.9 = 1.3. The required rate of return is then

simply: 4% + (6% - 4%)1.3 = 6.6%
10. A
With your financial calculator input the following:
-2 Input 8 +
12 Input 3 +
-8 Input 18 +
21 Input -7 +
0 y ,m
swap bC = -0.76
rC = 8% + (14% - 8%)(-0.76) = 8% - 4.58% = 3.42%
11. D
Portfolio beta is found from the CAPM:
17% = 7% + (14% - 7%)bp
bp = 1.4286
The portfolio beta is a weighted average of the betas of the stocks within the portfolio
1.4286 = (2/15)(0.8) + (5/15)(1.1) + (3/15)(1.4) + (5/15)bD

1.4286 = 0.1067 + 0.3667 + 0.2800 + (5/15)bD
0.6752 = 5/15bD
bD = 2.026
12. C
Step 1 Solve for risk-free rate
rs = 15% = rRF + (10% - rRF)2.0 = rRF + 20% - 2rRF
rRF = 5%
Step 2 Calculate new market return

rM increases by 30%, so rM = 1.3(10%) = 13%
Step 3 Calculate new required return on stock

rs = 5% + (13% - 5%)2 = 21%
Step 4 Calculate percentage change in return on stock

21% - 15%
= 40%
15%
13. E
bHR = 2.0; bLR = 0.5. No changes occur
rRF = 10%. Decreases by 3% to 7%
rM = 15%. Falls to 11%
Now SML: ri = rRF + (rM - rRF)bi
rHR = 7% + (11% - 7%)2 = 7% + 4%(2) = 15%
rLR = 7% + (11% - 7%)0.5 = 7% + 4%(0.5) = 9
Difference 6%
14. B
Using your financial calculator you find the mean to be 10.8 and the population
standard deviation to be 15.715. The coefficient of variation is just the standard
deviation divided by the mean, or 15.715/10.8 = 1.4551  1.46
15. B
The expected rate of return will equal 0.25(25%) + 0.5(15%) + 0.25(5%) = 15%. The
variance of the expected return is 0.25(25% - 15%)2 + 0.5(15% -15%)2 + 0.25(5% - 15%)2 =
0.0050. The standard deviation is the square root of 0.0050 = 0.0707. And, CV =
0.0707/0.15 = 0.47
16. C
Conditions Prob Return xReturn
Good 0.50 25% 12.50%
Average 0.30 10% 3.00%
Poor 0.20 -28% -5.60%
1.00 9.90% =Expected
Return
17. A
Expected return 25.0%
Standard deviation 30.0%
Coefficient of variation = Std dev/Expected return = 1.20
18. E
Company Investment Weight Beta Weight × Beta
X P35,000 0.35 1.50 0.53
Y P65,000 0.65 0.70 0.46
P100,000 1.00 0.98 = Portfolio beta
19. D
Real rate (r*): 3.00%
IP: 4.00%
RPM: 5.00%
Beta: 1.00
Required return = rRF + b(RPM) = r* + IP + b(RPM) = 12.00%
20. A
Use the SML to determine the market risk premium with the given data.
rs = rRF + bStock × RPM
12.25% = 5.00% + 1.25 × RPM
7.25% = RPM × 1.25
5.80% = RPM
21. B
Probability of Return This Deviation Squared State Prob

This State State from Mean Deviation x Sq. Dev
0.45 25% 6% 0.36% 0.1620%
0.50 15% -4% 0.16% 0.0800%
0.05 5% -14% 1.96% 0.0980%
Expected Return= 19% 0.34% 0.3400%
22. B
Original Portfolio
Stock Investment % Beta Product
A P50000 25% 0.95 0.238
B P50000 25% 0.80 0.200
C P50000 25% 1.00 0.250
D P50000 25% 1.20 0.300
E
Total P200000 100% 0.988
23. D
Original Portfolio New Portfolio
Stock Investment % Beta Product Beta Product
A P150000 40% 1.40 0.560 0.75 0.300
B P50000 13.33% 0.80 0.107 0.80 0.107
C P100000 26.67% 1.00 0.267 1.00 0.267
D P75000 20.00% 1.20 0.240 1.20 0.240
Total P375000 100% 1.173 New Portfolio Beta 0.913
Decreased by 0.260 (1.173-0.913)
24. E
Beta: Plankton 0.70
Beta: Karen 1.20
Market return 11.00%
Risk-free rate 4.25%
Market risk premium 6.75%
Required return Plankton = rRF + bA(RPM) = 8.98%
Required return Karen = rRF + bB(RPM) = 12.35%
Difference 3.38%
25. D
Real risk-free rate, r* 2.00%
Expected inflation, IP 3.00%
Market risk premium, RPM 4.70%
Beta, b 1.10 Risk-free rate = r* + IP = 5.00%
Required return = rRF + b(RPM) = 10.17B
rs = rRF + RPM
12.50% = 5.25% + RPM
RPM = 7.25%
rs = rRF + RPM × b
= 5.25% + 7.25% × 0.88
= 11.63%
26. A
Beta 1.23
Risk-free rate 4.30%
Required return on stock 11.75%
RPM = (rStock − rRF)/beta 6.06%
Required return on market = rRF + RPM = 10.36%
27. C
Number of stocks 8
Percent in each stock = 1/number of stocks = 12.500%
Portfolio beta 1.25
Stock that's sold 1.00
Stock that's bought 1.35
Change in portfolio's beta = 0.125 × (b2 – b1) = 0.0438
New portfolio beta 1.29
28. A
r = 9.5 = 4.2 + 1.05(rpm)
rpm = 5.0476%
New portfolio:
b = 1.05*(2/3) + 0.65*(1/3) = 0.9167
r = 4.2 + 0.9167(5.0476)
r = 8.83%
29. B
13 = 4.25 + b(6)
b = 1.458333
New portfolio:
1.458333 = 0.4(1) + 0.6b
b = 1.7639 or 1.76 B
Case Problem No. 1
1. B
E[RX] = 0.04(46%) + 0.73(14%) + 0.11(35%) + 0.12(-21%) = 13.39%
2. D
s2X = 0.04(0.46 - 0.1339)2 + 0.73(0.14 - 0.1339)2 + 0.11(0.35 - 0.1339)2 + 0.12(-0.21 -
0.1339)2 = 0.0236
3. D
sX = (0.0236)1/2 = 0.1537 = 15.37%
4. C
E[RY] = 0.04(-2%) + 0.73(31%) + 0.11(1%) + 0.12(37%) = 27.1%
5. A
s2Y = 0.04(-0.02 - 0.271)2 + 0.73(0.31 - 0.271)2 + 0.11(0.01 - 0.271)2 + 0.12(0.37 - 0.271)2 =
0.0132
6. D
sBY= (0.0132)1/2 = 0.1147 = 11.47%
7. A
sXY = 0.04(0.46 - 0.1339)(-0.02 - 0.271) + 0.73(0.14 - 0.1339)(0.31 - 0.271) + 0.11(0.35 -
0.1339)(0.01 - 0.271) + 0.12(-0.21 - 0.1339)(0.37 - 0.271) = -0.0139
8. C
rXY = -0.0139 = -0.789
Case Problem No. 2
1. E(R) = .4(15) + .6(9) = 11.4%
2. The square root of [.42 * .152 + .62 * .142 + 2(.4)(.6)(.5)(.15)(.14)] = 12.51%
3. 13 = w1(15) + (1-w1 )9 where w1 = amount in Jollibee. Solving for w1 = 67%
4. The standard deviation of the portfolio in part c would be the square root of [.672 * .152
+ .332 * .142 + 2(.67)(.33)(.5)(.15)(.14)] = 13.1%.
Case Problem No. 3
1. E(R) = rf + B[E(Rm) – rf], so E(GM) = 3 + 1(9 – 3) = 9%, E(IBM) = 3 + 1.2(9 – 3) = 10.2%,

E(WMT) = 3 + .7(9 – 3) = 7.2%
2. Beta for a portfolio equals the weighted sums of the individual betas. In this case, beta
for portfolio = 0.25(1) + 0.25(1.2) + .5(0.7) = 0.9
3. E(Return for portfolio) = 3 + 0.9*(9-3) = 8.4%
Case Problem No. 4
1. The expected return for A is .25(-5) + .5(8) + .25(12) = 5.75% and the expected return for
B is .25(-8) + .5(10) + .25(22) = 8.5%
2. The standard deviation for A is the square root of [25(-5-5.75)^2 + .5(8-5.75)^2 + .25(12-
5.75)^2] = 6.42% and the standard deviation for B is the square root of [.25(-8-8.5)^2 +
.5(10-8.5)^2 + .25(22-8.5)^2] = 10.62%
3. Stock B is riskier since its standard deviation of returns is higher. It is a more volatile
stock and thus should offer greater expected return
4. Two thirds of the time, returns should be within +/- 1 standard deviation of the
expected return. Thus for stock A, the range is 5.75% +/- 6.42% or between –.67 and
12.17%. For stock B, the range is 8.5% +/- 10.62% = -2.12 and 19.12
Case Problem No. 5
1. Mean = (0.30 x 7%) + (0.7 x 17%) = 14% per year. Standard deviation = 0.70 x 27% =
18.9% per year.
2. a.) Mean return on portfolio = Rf + (Rp - Rf)y = 7% + (17% - 7%)y = 7% + 10%y If the
mean of the portfolio is equal to 15%, then solving for y we will get: 15% = 7% +10%y =>
y = (15% - 7%)/10% => y = 0.8 Thus, in order to obtain a mean return of 15%, the client
must invest 80% of total funds in the risky portfolio and 20% in Treasure bills.
b.) Investment proportions of the client’s funds: • 20% in T-bills • 0.8 x 27% = 21.6% in
Stock A • 0.8 x 33% = 26.4% in Stock B • 0.8 x 40% = 32.0% in Stock C
3. a.) Portfolio standard deviation = y x 27%. If your client wants a standard deviation of
20%, then y = (20%/27%) = 0.7407 = 74.07% in the risky portfolio.
b.) Mean return = 7% + (17% - 7%)y = 7% + 10% (0.7407) = 7% + 7.407% = 14.407%.
Case Problem No. 6
a. E(Rр) = (1/3) 0.12 + (2/3) 0.18

= 0.16 or 16%
1 2 2 2 1 2
σ = √( ) (0.15)2 + ( ) (0.20)2 + 2 ( ) ( ) (0.5)(0.15)(0.20)
3 3 3 3
= √0.018055555
= 0.13437096 or 13.45%
b. The expected rate of return in each case is 13.45%.
Correlation: 0
σ = √(1/3)² (0.15)² + (2/3)²(0.20)² + 2(1/3)(2/3)(0)(0.15)(0.20)
= √0.011388888
=10.67%
Correlation: 1
σ = √(1/3)² (0.15)² + (2/3)²(0.20)² + 2(1/3)(2/3)(1)(0.15)(0.20)
= √0.030822221
=17.56%
c. As correlation decreases, standard deviation that measure total risk decreases. The risk
of a portfolio depends significantly on the correlation between the returns on the assets
in the portfolio. When the correlation is +1, the standard deviation of the portfolio is the
weighted average of the standard deviations of the individual assets. When the
correlation is less than +1, the standard deviation of the portfolio is less than the
weighted average of the standard deviations of the individual assets. By investing in
two shares that are less than perfectly correlated, Harry has achieved a diversification
benefit. This is demonstrated by the fact that when the correlation is 0.5, the risk of his
portfolio (13.45%) is less than the weighted average risk of the individual assets in the
portfolio (17.56%) when correlation coefficient is +1. In this case, the portfolio risk is
lowest (10.67%) when correlation coefficient is 0 but the expected returns are the same
throughout.
Case Problem No. 7
D1 + (P1 − P0)
a. return =
P0
. 60 + (18 − 16)
return = = 16.25%
16
. 25 + (20 − 16)
b. return = = 26.56%
16
. 10 + (13 − 16)
c. return = = −18.13%
16
Case Problem No. 8
a.
Return(ri) Probability(Pi) Expected Return (ri-ř)² (ri-ř)²(pi)
5% .20 1 49 9.8
10 .50 5 2 1
20 .30 6 64 19.2
ř = 12 σ² = 30
b. standard deviation (σ) = √30
= 5.48%
standard deviation
c. coefficient of variation =
expected return
5.48%
coefficient of variation = = 45.67%
12%
Case Problem No. 9
Security Invested Individual Expected Return

1 P5,000 7%
2 P10,000 9%
3 P15,000 12%
Total P30,000
a. security 1 weight = 5000/30000 =17%

b. security 2 weight = 10000/30000 = 33%
c. security 3 weight = 15000/30000 = 50%
d. portfolio expected return = (17%x7%)+(33%x9%)+(50%x12%) = 10.16%
Case Problem No. 10
a. Expected return (A) = 0.02 + 1.20(0.12) = 16.4%%.

Expected return (B) = 0.02 + 0.80(0.12) = 11.6%.
b. Expected return = 0.5(16.4%) + 0.5(11.6%) = 14%.

c. βP = 0.5(1.20) + 0.5(0.80) = 1

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Chapter 1 Introduction to Financial Management

TRUE-FALSE STATEMENTS Black - true and Red - false.

2. It is one of the objectives of financial management.

3. The choice to issue shares of stocks or long-term bonds falls under

4. The issuance of commercial paper is in the area of

10. Finance is ________.

11. Which of the following is a duty of a financial manager in a business firm?

12. The primary goal of a financial manager is ________.

13. Corporate owners receive return ________.

14. Which of the following is not a principle of basic financial management?

17. It is a weakness of a sole proprietorship

18. Which of the following is not an essential characteristic of a corporation?

19. Which of the following statements is an advantage of a sole proprietorship?

20. A business partnership is formed for the purpose of _________________________

MULTIPLE CHOICE QUESTIONS

MULTIPLE CHOICE PROBLEMS

2 D (P20,000 / 1.15%) = 17,391.30

3 A (P770 / 700) = 1.10

4 C (P750,000 - P600,000) / P600,000 = 0.25

5 D Average daily sales / 365 days

6 B A/R TO = Net credit sales/ average AR

7 C PES = MV per share / EPS = P50 / 5 = 10.00 times

8 C POR = Dividend per share / EPS = (P60,000 / 50,000 sh) / P5 0.20

10 B AR TO = Net sales / Average AR = 10 = ( NS / P400,000) = 4,000,000.00

11 A number of days = AAI / Average daily sales

13 A CAR = (P40,000 + P25,000 + P P20,000 ) / P60,000 = 1.42

14 C AR TO = Net Sales / Ave. AR = P85,000 / P25,000 = 3.40

15 B Inventory TO = Cost of Sales / Ave Inventory =

16 A ROA = Net income / Ave. investments = P20,000 / P295,000 = 0.068

17 C Profit Ratio = Net income / Net sales = P20,000 / P85,000 = 0.235

18 A ROE = Net income / SE = P20,000 / P150,000 = 0.133

19 A P E R = Market value per share / EPS = P20 / (P20,000 / 6,000 sh)

20 A Cash provided by operations / Average Current liabilities

21 D Debt / Equity ratio = Total Liabilities / Total SE

22 B P1,475,000 AR TO = Net credit Sales / Ave. AR =

23 D Inventory TO = P120,000 [(P25,000 + P35,000) / 2 ] = 4

24 B Inventory TO = COS / AAI = P480,000 / P80,000 = 6

25 A EPS = NI / Shares outstanding = P10,000 / 2,000 shares 5.00

26 B EPS = P50,000 / 100,000 = 0.50

29 C ROA = NI before Interest , net of tax / ave. total assets

30 D ROE = (NI - Dividend to PS ) / Common Stockholders' equity

31 B EPS = P28,800 / ( P60,000 / P20 par) = P28,800 / 3,000 sh = 9.60

33 A 5 = NS / [(P500,000 + P600,000 ) / 2] = P550,000

34 C P2,200,000 / [(P400,000 + P 600,000 *) / 2 ] = 4.4 times

35 A Sales P4,000,000 x 162.5% = 6,500,000.00

ROS = P650,000 / P6,500,000 = 0.10

36 C ROA = P650,000 / P2,600,000 = 0.25

37 C A T O = Net sales / Total assets = P6,500,000 / P2,600,000 2.50

38 B Total assets - Total liabilities = Stockholders' equity

39 C Sales = P120,000 / 10% = P1,200,000

2.1 a AR TO = P20,300 / [ (P7,500 + P6,800) / 2] =

b Inventory TO = P10,300 / [(P12,240 + P 8,700) / 2 ] =

2.2 a Current assets Ratio

b Quick asset ratio P260,000 / P 114,000 = 2.28

c Debt to total asset ratio = Total Debts / Total assets

d Profit margin ratio = Net income / Net sales

2.3 Change Percentage

2.4 2019 2018 2017

2 Number of times interest earned ratio = EBIT / Interest expense

3 Accounts Receivable Turnover = Net Sales / Ave. AR

4 Return on Assets ratio in 2008 = Net Income / Total assets =

5 Current cash debt coverage ratio =

2.6 a Current ratio = P270,000 / P170,000 = 1.588

Savings - interest (3P100,0005%) 15,000