FINANCIAL MANAGEMENT – Working Capital

1. Net working capital is the difference between

A. Current assets and current liabilities.
B. Fixed assets and current liabilities.
C. Total assets and total liabilities.
D. Shareholders' investment and cash.

2. As a company becomes more conservative in working capital policy, it would tend to have
a(an)
A. Decrease in its acid-test ratio.
B. Increase in the ratio of current liabilities to non-current liabilities.
C. Increase in the ratio of current assets to units of output.
D. Increase in funds invested in common stock and a decrease in funds invested in marketable
securities.

3. All of the following statements in regard to working capital are correct except
A. Current liabilities are an important source of financing for many small firms.
B. Profitability varies inversely with liquidity.
C. The hedging approach to financing involves matching maturities of debt with specific
financing needs.
D. Financing permanent inventory buildup with long-term debt is an example of an aggressive
working capital policy.

4. Which one of the following transactions would increase the current ratio and decrease net
profit?
A. An income tax payment due from the previous year is paid.
B. A stock dividend is declared.
C. Uncollectible accounts receivable are written off against the allowance account.
D. Vacant land is sold for less than the net book value.
5. The fundamental analysis of cash flow generated from operations may-be determined using
any of the following except
A. After tax income plus depreciation
B. Profit less depreciation plus taxes
C. Profit plus depreciation
D. Cash sales less cash operating costs less taxes paid

6. Which of the following is not a use of working capital?

A. Repurchase of common stock.
B. Purchase of inventory on account.
C. Purchase of equipment of account.
D. Repayment of long-term debt.

7. Determining the appropriate level of working capital of the firm requires

A. Evaluating the risk associated with various levels of fixed assets and the types of debt used to
finance those assets.
B. Changing the capital structure and dividend policy of the firm.
C. Maintaining a high proportion of liquid assets to total assets in order to maximize the return
on total investment.
D. Offsetting the profitability of technical insolvency.

8. The amortization of goodwill appearing in the income statement is

A. Deducted from profit to obtain "Funds provided by operations".
B. Added to profit to obtain "Funds provided by operation".
C. A source of working capital separate from profit.
D. A use of working capital.
9. Compared to other firms in the industry, a company that maintains a conservative working
capital policy will tend to have a
A Greater percentage of short-term financing.
B. Greater risk of needing to sell current assets to repay debt.
C. Higher ratio of current assets to fixed assets.
D. Higher total asset turnover.

10. Which of the following account changes would be classified as a use of funds?
A. An increase in accounts payable.
B. An increase in retained earnings.
C. A decrease in bonds payable.
D. A decrease in accounts receivable.

11. Which of the following would reduce the additional funds required if all other things are
held constant?
A. A decrease in the company’s tax rate.
B. An increase in the expected sales growth rate.
C. An increase in the dividend payout ratio.
D. A decrease in the profit margin

12. Determining the appropriate level of working capital for a firm requires
A. Changing the capital structure and dividend policy of the firm.
B. Maintaining short-term debt at the lowest possible level because it is generally more
expensive than long-term debt.
C. Offsetting the benefit of current assets and current liabilities against the probability of
technical insolvency.
D. Maintaining a high proportion of liquid assets to total assets in order to maximize the return
on total investments.
13. Which one of the following transactions does not change the current ratio and does not
change the total current assets?
A. A cash advance is made to a divisional office.
B. A cash dividend is declared.
C. Short-term notes payables are retired with cash.
D. A fully depreciated asset is sold for cash.

14. Bankerohan Company used the working capital basis of preparing its Fund Flow Statement.
The following data are presented for the year just ended:
Depreciation expense P48,500
Amortization of patents 12,000
Cash dividends declared 27,000
Cash dividends paid 34,000
Bonds payable issued 90,000
Sale of common stock 175,000
Amortization of bonds discount 1,500
Gain on sale of equipment 9,500
Working capital provided by operations 121,000
Purchase of land 310,000
Decrease in deferred income taxes 18,000
Calculate the profit or loss for the period from the above data.
A. P68,500
C. P113,500
B. P86,500
D. P351,500

SOLUTIONS:
Working capital provided by operations P121,000
Add (Deduct) Non-working capital items:
Depreciation expense (48,500)
Amortization of patents (12,000)
Amortization of bond discounts (1,500)
Gain on sale of equipment 9,500
Profit P 68,500

15. The working capital RED Company at December 31, 2012 was P10,000,000. Selected
information for the year 2013 for RED Company is as follows:
Working capital provided from operations P1,700,000
Capital expenditure 3,000,000
Proceeds from short-term borrowings 1,000,000
Proceeds from long-term borrowings 2,000,000
Payments on short-term borrowings 500,000
Payments on long-term borrowings 600,000
Proceeds from issuance of common stock 1,400,000
Dividends paid on common stock 800,000
What is RED working capital at December 31, 2013?
A. P11,200,000
B. P11,500,000
C. P10,700,000
D. P12,000,000
SOLUTIONS:
Working capital - 12/31/12 P10,000,000
Sources of working capital in 2013:
From operations 1,700,000
From long-term borrowings 2,000,000
 From issuance of common stock 1,400,000
Uses of working capital in 2013:
Capital expenditures (3,000,000)
Payments to long-term borrowings (600,000)
Dividends paid (800,000)
* Working capital - 12/31/13 P10.700,000

16. During 2013, Mason Company's current assets increased by P120, current liabilities
decreased by P50, and net working capital
A. Increased by P70.
B. Did not change.
C. Decreased by P170.
D. Increased by P170.

17. Spotech Company's budgeted sales and budgeted cost of sales for the coming year are
P212,000,000 and P132,500,000, respectively. Short-term interest rates are expected to
average 5%. If Spotech could increase inventory turnover from its current 8.0 times per year to
10.0 times, per year, its expected cost savings in the current year would be
A. P165,625
B. P 0
C. P3,312,500
D. P 828,125

SOLUTIONS:
Before After
Cost of goods sold P132,500,000 P132,500,000
Inventory turnovers 8 times 10 times
Inventory balances P16,562,500 P 13,250,000
Decrease in inventory P 3,312,500
Costs savings (P3,312,500 x 5%) P 165.625

18. Management of a company does not want to violate a working capital restriction contained
in its bond indenture. If the firm's current ratio falls below 2.0 to 1, technically it will have
defaulted. The firm's current ratio is now 2.2 to 1. If current liabilities are P200 million, the
maximum new commercial paper that can be issued to finance inventory expansion is
A. P20 million.
B. P40 million.
C. P240 million.
D. P180 million.

SOLUTIONS:
If: X the maximum amount of new commercial paper
Then: (P440 million + X)/ (P200 million + X) = 2.0
Therefore = P440 million+ X = P400 million + 2X
X = P40 million

19. MFA Corporation has 100,000 shares of stock outstanding. Below is part of MFC's
Statement of Financial Position for the last fiscal year.
MFA Corporation
Statement of Financial Position - Selected Items
December 31, 2013
Cash P455,000
Accounts receivable 900,000
Inventory 650,000
Prepaid assets 45,000
Accrued liabilities 285,000
Accounts payable 550,000
Current portion, long-term notes payable 65,000
What is the maximum amount MFA can pay in cash dividends per share and maintain a
minimum current ratio of 2 to 1. Assume that all accounts other than cash remain unchanged.
A. P2.05
B. P2.50
C. P3.35
D. P3.80

SOLUTIONS:
The key point is to maintain a current ratio of 2 to 1. The current liabilities total P900,000 (ie.,
P285,000+P550,000+ P65,000) and this serves as the basis of maintaining the current ratio. The
maximum amount that could be paid in cash dividend per share is P2.50, calculated as follows:

Old current assets (P455,000 + P900,000+ P650,000+ P45,000) P2,050,000

Maintained current assets (P900,000 x 2) 1,800,000
Allowed reduction in cash for dividends P 250,000
Dividend per share (P250,000/100,000 shares) P 2.50

[Link] that each day a company writes and received checks totaling P10,000. If it takes 5
days for the checks to clear and be deducted from the company’s account, and only 4 days for
the deposits to clear, what is the float?
A.P10,000 C. P(10,000)
B.P0 D. P50,000(cma)
14. A ?The amount of the float. The float referred here is the net float. A float is a time spent
between the day the check is written until the day the check is withdrawable or the deposit is
cleared. The net float refers to the difference of the check float and the deposit float, as
follows:
Check float (P10,000 x 5 days) P50,000
Deposit float (P10,000 x 4 days) ( 40,000)
Net float(P10,000 x 1 day) P10,000

15. Butit is a newly established janitorial firm, and the owner is deciding what type of checking
account to open. Butit is planning to keep a P500 minimum balance in the account for
emergencies and plans to write roughly 80 checks per month. The bank charges P10 per month
per P0.10 per check charge for a standard business checking account with no minimum balance.
Butit also has the option of a premium business balance that requires a P2,500 minimum
balance but has no monthly fees or per check charges. If Butit’s cost of funds is 10%, which
account should Butit choose?
[Link] account, because the savings is P34 per year.
[Link] account, because the savings is P34 per year.
[Link] account because the savings is P16 per year.
[Link] account because the savings is P16 per year
The checking account that should be chosen. The checking account to be maintained should
give the lower cost of using the checking account facility, as follows:
Cost of using a standard checking account
Bank charges [P10 + (80 x P0.10) x 12 mos.] P216.00
Cost of funds (P500 x 10%) 50.00 P266.00
Cost of using premium checking account (P2,500 x 10%) 250.00
Advantage of using the premium checking account P 16.00

16. Globe Products has received proposals from several banks to establish a lock box system to
speed up receipts. Globe receives an average of 700 checks per day averaging P1,800 each, and
its cost of short-term funds is 7% per year. Assuming that all proposals will produce equivalent
processing results and using a 360-day year, which one of the following proposals is optimal for
Globe?
A.A P0.50 per check.
B.A flat fee of P125,000 per year.236
C.A fee of 0.03% of the amount collected.
D.A compensating balance of P1,750,000.

The optimal proposal received from several banks. The business receives 700 checks per day,
an average of P1,800 a day, and a cost of funds of 7% per year. The costs of the several
proposals are:
 Cost of proposals
a.P0.50 per check (700 checks x P0.50 x 360 days) P126,000
[Link] fee 125,000
c.0.03% of amount collected (P1,800 x 700 checks x 360 days x 0,03%) 136,080
[Link] balance (P1,750,000 x 7%) 122,500 (lowest)

Proposal “d”, maintaining a compensating balance of 1,750,000 would only cost the business
P122,500, and has the lowest cost among the proposals submitted, and therefore is the most
desirable and optimal proposal.

Franklin, Inc., is a medium-size manufacturer of toys that makes 25% of its sales to Mel
Company, a major national discount retailing firm. Mel will be requiring Franklin and other
suppliers to use Electronic Data Interchange (EDI) for inventory replenishment and trade
payments transactions as opposed to the paper-based systems previously used. Franklin would
consider all of the following to be advantages using EDI in its dealings with Mel except
[Link] to Mel’s inventory balances of Franklin’s products.
[Link] status of deliveries and payments.
[Link] with Franklin’s other procedures and systems.
[Link] in the payment float.

A disadvantage using EDI in dealing with a supplier. Electronic data interchange (EDI) is an
electronic system where a company that has an interest over the operational schedules of
another (e.g., its customers) taps the advantages of advance communication and computer
technologies in order to deliver services on time and upholding the best interest of the
receiving party. For example, this method allows a supplier to dip or access over the database
of its customer to predict production needs and serve schedules on time to eliminate delays (or
production float) in the production process. This process ensures better status of deliveries and
results to timely payments on the part of the buying party. Choice- letters “a”, “b”, and “c” are
advantages of the EDI and are not the correct answers. Choice-letter “d” is incorrect and is the
correct answer because reduction in the payment float would not lengthen the payment period
and is a disadvantage using the EDI.

101. CMR is a retail mail order firm currently using a central collection system that requires all
checks to be sent to its Boston headquarters. An average of 5 days is required for mailed checks
to be received, 4 days for CMR to process them, and 1 1/2 days for the checks to clear through
the bank. A proposed lockbox system would reduce the mail and process time to 3 days and the
check clearing time to 1 day. CMR has an average daily collection of $100,000. If CMR should
adopt the lockbox system, its average cash balance would increase by
A. $250,000
b. $400,000
c.$650,000
d.$800,000

Answer (A) is incorrect. This figure results from adding the old clearing time and the new
clearing time.
Answer (B) is incorrect. This figure results from simply adding the new process time and the
new clearing time.
Answer (C) is correct. Checks are currently tied up for 10 1/2 days (5 for mailing, 4 for
processing, and 1 1/2 for clearing). If that were reduced to 4 days, CMR’s cash balance would
increase by $650,000 ($100,000 per day × 6 1/2 days).
Answer (D) is incorrect. This figure results from simply adding the mail time and the new
process time.

Foster, Inc. is considering implementing a lockbox collection system at a cost of $80,000 per
year. Annual sales are $90 million, and the lockbox system will reduce collection time by 3 days.
If Foster can invest funds at 8%, should it use the lockbox system? Assume a 360-day year.
A. Yes, producing savings of $140,000 per year.
B. Yes, producing savings of $60,000 per year.
C. No, producing a loss of $20,000 per year.
D. No, producing a loss of $60,000 per year

Answer (A) is incorrect. This figure results from improperly adding, rather than subtracting, the
cost of the lockbox.
Answer (B) is incorrect. This figure results from failing to subtract the cost of the lockbox.
Answer (C) is correct. The annual benefit (loss) from using the lockbox system is the excess
(deficit) of interest earned on the early deposits over (under) the cost of the service. If the plan
is adopted, Foster’s average cash balance will increase by $750,000 [$90,000,000 × (3 days ÷
360 days)].
Benefit (loss) =Interest earned – Cost
=($750,000 × 8%) – $80,000
=$60,000 – $80,000
= $(20,000)
Answer (D) is incorrect. This figure is the interest revenue that would be earned on the early
deposits.
A company has daily cash receipts of $150,000. The treasurer of the company has investigated
a lockbox service whereby the bank that offers this service will reduce the company’s collection
time by four days at a monthly fee of $2,500. If money market rates average 4% during the
year, the additional annual income (loss) from using the lockbox service would be
A. $6,000
B. $(6,000)
C. $12,000
D. $(12,000)

Answer (A) is incorrect. This figure results from reversing the subtraction of the cost of the
lockbox.
Answer (B) is correct. The additional annual income (loss) from using the lockbox service is the
excess (deficit) of interest earned on the accelerated deposits over (under) the cost of the
service. If the plan is adopted, the company’s average cash balance will increase by $600,000
($150,000 × 4 days).
Benefit (loss)=Interest earned – Cost
=($600,000 × 4%) – ($2,500 × 12 months)
=$24,000 – $30,000
= $(6,000)
Answer (C) is incorrect. The loss is $6,000, the difference between the $24,000 of additional
interest revenue and the $30,000 total service charge.
Answer (D) is incorrect. The loss is $6,000, the difference between the $24,000 of additional
interest revenue and the $30,000 total service charge

A firm has daily cash receipts of $100,000 and collection time of 2 days. A bank has offered to
reduce the collection time on the firm’s deposits by 2days for a monthly fee of $500. If money
market rates are expected to average 6% during the year, the net annual benefit (loss) from
having this service is
A.$3,000
B. $12,000
C. $0
D.$6,000
Answer (D) is correct. The annual benefit (loss) from using the bank’s proposed service is the
excess (deficit) of interest earned on the early deposits over (under) the cost of the service. If
the plan is adopted, the firm’s average cash balance will increase by $200,000 ($100,000 × 2
days).
Benefit (loss) = Interest earned –Cost
= ($200,000 × 6%) –($500 × 12 months)
= $12,000 –$6,000 = $6,000
A firm has daily cash receipts of $200,000. A commercial bank has offered to reduce the
collection time by 3 days. The bank requires a monthly fee of $4,000 for providing this service.
If money market rates will average 12% during the year, the additional annual income (loss) of
having the service is
A.$(24,000)
B. $24,000
C. $66,240
D.$68,000
Answer (B) is correct. The additional annual income (loss) from using the bank’s proposed
service is the excess (deficit) of interest earned on the early deposits over (under) the cost of
the service. If the plan is adopted, the firm’s average cash balance will increase by $600,000
($200,000 × 3 days).
Benefit (loss) = Interest earned –Cost
= ($600,000 × 12%) –($4,000 × 12 months)
= $72,000 –$48,000
= $24,000

A firm has daily cash receipts of $300,000. A bank has offered to provide a lockbox service that
will reduce the collection time by 3 days. The bank requires a monthly fee of $2,000 for
providing this service. If money market rates are expected to average 6% during the year, the
additional annual income (loss) of using the lockbox service is
A.$(24,000)
B.$12,000
C.$30,000
D.$54,000
Answer (C) is correct. The additional annual income (loss) from using the lockbox service is the
excess (deficit) of interest earned on the early deposits over (under) the cost of the service. If
the plan is adopted, the firm’s average cash balance will increase by $900,000 ($300,000 × 3
days).
Benefit (loss) = Interest earned –Cost
= ($900,000 × 6%) –($2,000 × 12 months)
= $54,000 –$24,000
= $30,000

A firm has daily cash receipts of $300,000. A commercial bank has offered to reduce the
collection time by 2 days. The bank requires a monthly fee of $3,000 for providing this service.
If the money market rates will average 11% during the year, the annual pretax income (loss)
from using the service is
A.$(30,000)
B.$30,000
C.$66,000
D. $63,000
Answer (B) is correct. The additional annual income (loss) from using the bank’s proposed
service is the excess (deficit) of interest earned on the early deposits over (under) the cost of
the service. If the plan is adopted, the firm’s average cash balance will increase by $600,000
($300,000 × 2 days).
Benefit (loss) = Interest earned –Cost
= ($600,000 × 11%) –($3,000 × 12 months)
= $66,000 –$36,000
= $30,000