Financial Management

(B. Working Capital Management)

B. WORKING CAPITAL MANAGEMENT to have a(n)

A. Increase in the ratio of current liabilities to noncurrent liabilities.
B. Increase in the operating cycle.
THEORIES: C. Decrease in the operating cycle.
Working capital management D. Increase in the ratio of current assets to current liabilities.
1. Working capital management involves investment and financing decisions related to:
A. plant and equipment and current liabilities. Moderate
B. current assets and capital structure. 3. Short-term financing plans with high liquidity have:
C. current assets and current liabilities. A. high return and high risk
D. sales and credit. B. moderate return and moderate risk

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C. low profit and low risk

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17. The goal of managing working capital, such as inventory, should be to minimize the: D. none of the above
A. costs of carrying inventory
B. opportunity cost of capital Temporary & Permanent working capital

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C. aggregate of carrying and shortage costs 4. Temporary working capital supports

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D. amount of spoilage or pilferage A. the cash needs of the company. C. acquisition of capital equipment.
B. payment of long term debt. D. seasonal peaks.

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Working capital financing policy
Aggressive Cash Management
5. Zap Company follows an aggressive financing policy in its working capital management while Motives for holding cash

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Zing Corporation follows a conservative financing policy. Which one of the following 7. The transaction motive for holding cash is for:

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statements is correct? A. a safety cushion C. compensating balance requirements
A. Zap has low ratio of short-term debt to total debt while Zing has a high ratio of short-term B. daily operating requirements D. none of the above
debt to total debt.

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B. Zap has a low current ratio while Zing has a high current ratio. Float
C. Zap has less liquidity risk while Zing has more liquidity risk. 8. The difference between the cash balance on the firm's books and the balance shown on the

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D. Zap finances short-term assets with long-term debt while Zing finances short-term assets bank statement is called:
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with short-term debt. A, the compensating balance C. a safety cushion
B. float D. none of the above
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6. Which of the following would increase risk?
A. Raise the level of working capital. Cash conversion cycle
B. Decrease the amount of inventory by formulating an effective inventory policy. 9. The length of time between payment for inventory and the collection of cash is referred to as:
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C. Increase the amount of short-term borrowing. A. payables deferral period C. operating cycle
D. Increase the amount of equity financing. B. receivables conversion period D. cash conversion cycle

Conservative 10. As a firm's cash conversion cycle increases, the firm:

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2. As a company becomes more conservative with respect to working capital policy, it would tend A. becomes less profitable
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 Financial Management
(B. Working Capital Management)

B. increases its investment in working capital A. decreases by the amount of the safety stock.
C. reduces its accounts payable period B. is one-half the level of the safety stock.
D. incurs more shortage costs C. Increases by one-half the amount of the safety stock.
D. Increases by the number of units of the safety stock.
11. The longer the firm's accounts payable period, the:
A. longer the firm's cash conversion cycle is. 19. Which of the following statements is correct for a firm that currently has total costs of carrying
B. shorter the firm's inventory period is. and ordering inventory that are 50% higher than total carrying costs?
C. more the delay in the accounts receivable period. A. Current order size is greater than optimal
D. less the firm must invest in working capital. B. Current order size is less than optimal
C. Per unit carrying costs are too high

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12. The average length of time a peso is tied up in current asset is called the: D. The optimal order size is currently being used

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A. net working capital. C. receivables conversion period.
B. inventory conversion period. D. cash conversion period. Trade credit
20. With credit terms of 3/8, n/30, what is the customer’s payment decision date?

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Receivables management A. Three days after the invoice is received.

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13. All of these factors are used in credit policy administration except: B. The 8th day is the customer’s decision date.
A. credit standards C. peso amount of receivables C. Anytime during the period, 8th to the 30th.

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B. terms of trade D. collection policy D. The 30th day is the primary decision date.

14. Which of the following statements is most correct? If a company lowers its DSO, but no PROBLEMS

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changes occur in sales or operating costs, then: Working capital financing

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A. the company might well end up with a higher debt ratio. 1. Casie Company turns out 200 calculators a day at a cost of P250 per calculator for materials
B. the company might well end up with a lower debt ratio. and variable conversion cost. It takes the firm 18 days to convert raw materials into calculator.
C. the company would probably end up with a higher ROE. Casie’s usual credit terms extended to its customers is 30 days, and the firm generally pays its

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D. the company's total asset turnover ratio would probably decline. suppliers in 20 days.
If the foregoing cycles are constant, what amount of working capital must Casie Company

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15. All but which of the following is considered in determining credit policy? finance?
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A. Credit standards C. Accounts payable deferral period A. P1,400,000 C. P 900,000
B. Credit limits D. Collection efforts B. P2,400,000 D. P1,800,000
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Inventory management Cash conversion cycle
16. The use of safety stock by a firm will: 2. Luke Company has an inventory conversion period of 60 days, a receivables conversion
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A. reduce inventory costs C. have no effect on inventory costs period of 45 days, and a payments cycle of 30 days. What is the length of the firm’s cash
B. increase inventory costs D. none of the above conversion cycle?
A. 90 days C. 54 days
18. When a specified level of safety stock is carried for an item in inventory, the average inventory B. 75 days D. 105 days
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level for that item

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 Financial Management
(B. Working Capital Management)

3. The Spades Company has an inventory conversion period of 75 days, a receivables to be paid uniformly. Hyperbole has the opportunity to invest the money at 9% per annum. The
conversion period of 38 days, and a payable payment period of 30 days. What is the length of company spends, on the average, P25 for every cash conversion to marketable securities and
the firm’s cash conversion cycle? vice versa.
A. 83 days C. 67 days What is the opportunity cost of keeping cash in the bank account?
B. 113 days D. 45 days A. P3,825.00 C. P4,190.00
B. P1,912.50 D. P 188.55
4. Samaritan Supplies, Inc. has P5 million in inventory and P2 million in accounts receivable. Its
average daily sales are P100,000. The company has P1.5 million in accounts payable. Its Annual savings
average daily purchases are P50,000. What is the length of the company’s cash conversion 9. What are the expected annual savings from a lock-box system that collects 150 checks per
period? day averaging P500 each, and reduces mailing and processing times by 2.5 and 1.5 days

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A. 50 days C. 30 days respectively, if the annual interest rate is 7%?

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B. 20 days D. 40 days A. P 5,250 C. P 21,000
B. P 13,125 D. P300,000
Days inventory

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5. What is the inventory period for a firm with an annual cost of goods sold of P8 million, P1.5 Receivables management

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million in average inventory, and a cash conversion cycle of 75 days? Carrying cost
A. 6.56 days C. 52.60 days 10. The Camp Company has an inventory conversion period of 60 days, a receivable conversion

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B. 18.75 days D. 67.50 days period of 30 days, and a payable payment period of 45 days. The Camp’s variable cost ratio
is 60 percent and annual fixed costs of P600,000. The current cost of capital for Camp is 12%.
6. Samaritan Supplies, Inc. has P5 million in inventory and P2 million in accounts receivable. Its If Camp’s annual sales are P3,375,000 and all sales are on credit, what is the firm’s carrying

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average daily sales are P100,000. The company has P1.5 million in accounts payable. Its cost on accounts receivable, using 360 days year?

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average daily purchases are P50,000. What is the length of the company’s inventory A. P281,250 C. P 20,250
conversion period? B. P168,750 D. P 56,250
A. 50 days C. 120 days

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B. 90 days D. 40 days Average receivables
11. Caja Company sells on terms 3/10, net 30. Total sales for the year are P900,000. Forty
Cash management
m e percent of the customers pay on the tenth day and take discounts; the other 60 percent pay,
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Economic conversion quantity (ECQ) on average, 45 days after their purchases.
7. Simile Inc. has a total annual cash requirement of P9,075,000 which are to be paid uniformly. What is the average amount of receivables?
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Simile has the opportunity to invest the money at 24% per annum. The company spends, on A. P70,000 C. P77,200
the average, P40 for every cash conversion to marketable securities. B. P77,500 D. P67,500
What is the optimal cash conversion size?
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A. P60,000 C. P45,000 12. Palm Company’s budgeted sales for the coming year are P40,500,000 of which 80% are
B. P55,000 D. P72,500 expected to be credit sales at terms of n/30. Palm estimates that a proposed relaxation of
credit standards will increase credit sales by 20% and increase the average collection period
Opportunity cost from 30 days to 40 days. Based on a 360-day year, the proposed relaxation of credit to
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8. Hyperbole Corporation estimates its total annual cash disbursements of P3,251,250 which are standards will result in an expected increase in the average accounts receivable balance of
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 Financial Management
(B. Working Capital Management)

A. P 540,000 C. P2,700,000 A. P68,493 C. P60,615

B. P 900,000 D. P1,620,000 B. P65,640 D. P57,615

Investment in receivables Inventory management

13. Currently, La Carlota Company has annual sales of P2,500,000. Its average collection period EOQ
is 45 days, and bad debts are 3 percent of sales. The credit and collection manager is 17. What is the economic order quantity for the following inventory policy: A firm sells 32,000 bags
considering instituting a stricter collection policy, whereby bad debts would be reduced to 1.5 of premium sugar per year. The cost per order is P200 and the firm experiences a carrying
percent of total sales, and the average collection period would fall to 30 days. However, sales cost of P0.80 per bag.
would also fall by an estimated P300,000 annually. Variable costs are 75 percent of sales and A. 2,000 bags C. 8,000 bags
the cost of carrying receivables is 10 percent. Assume a tax rate of 40 percent and 360 days B. 4,000 bags D. 16,000 bags

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per year.

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What would be the decrease in investment in receivables if the change were made? Annual demand
A. P 9,688 C. P 96,875 18. Marsman Co. has determined the following for a given year:
B. P 12,988 D. P129,975 Economic order quantity (standard order size) 5,000 units

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Total cost to place purchase orders for the year P40,000

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Comprehensive Cost to place one purchase order P 100
Question Nos. 14 through 16 are based on the following data: Cost to carry one unit for one year P 4

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Sonata Company is considering changing its credit terms from 2/15, net 30 to 3/10, net 30 in order What is Marsman’s estimated annual usage in units?
to speed collections. At present, 40 percent of Sonata Company‘s customers take the 2 percent A. 1,000,000 C. 500,000
discount. Under the new term, discount customers are expected to rise to 50 percent. Regardless B. 2,000,000 D. 1,500,000

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of the credit terms, half of the customers who do not take the discount are expected to pay on time,

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whereas the remainder will pay 10 days late. The change does not involve a relaxation of credit Required annual return on investment
standards; therefore bad debt losses are not expected to rise above their present 2 percent level. 19. BIBO Company is a distributor of videotapes. Pirate Mart is a local retail outlet which sells
However, the more generous cash discount terms are expected to increase sales from P2 million blank and recorded videos. Pirate Mart purchases tapes from BIBO Company at P300.00 per

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to P2.6 million per year. Sonata Company’s variable cost ratio is 75 percent, the interest rate on tape; tapes are shipped in packages of 20. BIBO Company pays all incoming freight, and
funds invested in accounts receivable is 9 percent, and the firm’s income tax rate is 40 percent. Pirate Mart does not inspect the tapes due to BIBO Company's reputation for high quality.

m e Annual demand is 104,000 tapes at a rate of 4,000 tapes per week. Pirate Mart earns 20% on
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14. What are the days sales outstanding (DSO) before and after the change of credit policy? its cash investments. The purchase-order lead time is two weeks.
A. 27.0 days and 22.5 days, respectively C. 22.5 days and 21.5 days, respectively The following cost data are available:
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B. 22.5 days and 27.0 days, respectively D. 21.5 days and 22.5 days respectively Relevant ordering costs per purchase order P80 P90.50
Carrying costs per package per year 3
Relevant insurance, materials handling, breakage, etc., per year 2 P 4.50
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15. The incremental carrying cost on receivable is What is the required annual return on investment per package?
A. P 843.75 C. P 643.75 A. P6,000 C. P1,200
B. P8,889.00 D. P6,667.00 B. P 250 D. P 600
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16. The incremental after tax profit from the change in credit terms is Order quantity
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 Financial Management
(B. Working Capital Management)

20. For Raw Material L12, a company maintains a safety stock of 5,000 pounds. Its average 23. Durable Furniture Company uses about 200,000 yards of a particular fabric each year. The
inventory (taking into account the safety stock) is 12,000 pounds. What is the apparent order fabric costs P25 per yard. The current policy is to order the fabric four times a year.
quantity? Incremental ordering costs are about P200 per order, and incremental carrying costs are
A. 18,000 lbs. C. 14,000 lbs. about P0.75 per yard, much of which represents the opportunity cost of the funds tied up in
B. 6,000 lbs. D. 24,000 lbs inventory.
How much total annual costs are associated with the current inventory policy?
Optimal safety stock level A. P19,550 C. P38,300
21. Each stockout of a product sold by Arnis Co. costs P1,750 per occurrence. The company’s B. P18,750 D. P62,500
carrying cost per unit of inventory is P5 per year, and the company orders 1,500 units of
product 20 times a year at a cost of P100 per order. The probabilities of a stockout at various Maximum interest rate

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levels of safety stock are: 24. Narra Company is considering a switch to level production. Cost efficiencies will occur under

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Units of Safety Stock Probability of Stockout level production and after tax cost would decline by P70,000 but inventory would increase
0. 0.50 from P1,000,000 to P1,800,000. Narra would have to finance the extra inventory at a cost of
100. 0.30 10.5 percent.

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200. 0.14 What is the maximum interest rate that makes level production feasible?

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300. 0.05 A. 7.00 percent C. 8.75 percent
400. 0.01 B. 5.83 percent D. 10.00 percent

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The optimal safety stock level for the company based on the units of safety stock level above
is Opportunity cost
25. Diesel Fashion estimates that 90,000 zippers will be needed in the manufacture of high selling

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A. 200 units C. 100 units
B. 300 units D. 400 units products for the coming year. Its supplier quoted a price of P25 per zipper. Diesel planned to

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purchase 7,500 units per month but its supplier could not guarantee this delivery schedule. In
22. Paeng Company uses the EOQ model for inventory control. The company has an annual order to ensure availability of these zippers, Diesel is considering the purchase of all these
90,000 units on January 1. Assuming Diesel can invest cash at 12%, the company’s

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demand of 50,000 units for part number 6702 and has computed an optimal lot size of 6,250
units. Per-unit carrying costs and stockout costs are P9 and P4, respectively. The following opportunity cost of purchasing the 90,000 units at the beginning of the year is
data have been gathered in an attempt to determine an appropriate safety stock level: A. P127,500 C. P123,750

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Units Short Because of Excess Number of Times Short B. P135,000 D. P264,000
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Demand during the Lead Time Period in the last 40 Reorder Cycles
100 8 Trade credit
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200 10 26. If a firm is given a trade credit terms of 2/10, net 30, then the cost to the firm failing to take the
300 14 discount is:
400 8 A. 2.0%. C. 36.7%
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What is the optimal safety stock level? B. 30.0%. D. 10.0%.

A. 100 units C. 200 units
B. 300 units D. 400 units 27. The cost of discounts missed on credit terms of 2/10, n/60 is
A. 2.0 percent C. 12.4 percent
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Annual inventory costs B. 14.9 percent D. 21.2 percent

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 Financial Management
(B. Working Capital Management)

Bank loans 33. Every 15 days a company receives P10,000 worth of raw materials from its suppliers. The
Discount loan credit terms for these purchases are 2/10, net 30, and payment is made on the 30th day after
28. You plan to borrow P10,000 from your bank, which offers to lend you the money at a 10 each delivery. Thus, the company is considering a 1-year bank loan for P9,800 (98% of the
percent nominal, or stated, rate on a one-year loan. What is the effective interest rate if the invoice amount). If the effective annual interest rate on this loan is 12%, what will be the net
loan is a discount loan? peso savings over the year by borrowing and then taking the discount on the materials?
A. 10.00% C. 12.45% A. P3,624 C. P4,800
B. 11.11% D. 14.56% B. P1,176 D. P1,224

Discount loan with compensating balance 34. An invoice of a P100,000 purchase has credit terms of 1/10, n/40. A bank loan for 8 percent

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29. What is the effective rate of a 15% discounted loan for 90 days, P200,000, with 10% can be arranged at any time. When should the customer pay the invoice?

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compensating balance? Assume 360 days per year. A. Pay on the 1st. C. Pay on the 40th
A. 20.0% C. 17.4% B. Pay on the 10th D. Pay on the 60th
B. 15.0% D. 22.2%

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Compensating balance with interest 35. The Peninsula Commercial Bank and Island Corporation agreed to the following loan proposal:
30. The Premiere Company obtained a short-term bank loan for P1,000,000 at an annual interest • Stated interest rate of 10% on a one-year discounted loan; and

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rate 12%. As a condition of the loan, Premiere is required to maintain a compensating • 15% of the loan as compensating balance on zero-interest current account to be
balance of P300,000 in its checking account. The checking account earns interest at an maintained by Island Corporation with Peninsula Commercial Bank.
annual rate of 3%. Premiere would otherwise maintain only P100,000 in its checking account The loan requires a net proceeds of P1.5 million. What is the principal amount of loan applied

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for transactional purposes. Premiere’s effective interest costs of the loan is for as part of the loan agreement?

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A. 12.00% C. 16.30% A. P1,666,667 C. P1,764,706
B. 14.25% D. 15.86% B. P2,000,000 D. P1,125,000

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Add-on
31. Perlas Company borrowed from a bank an amount of P1,000,000. The bank charged a 12%

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stated rate in an add-on arrangement, payable in 12 equal monthly installments.
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A. 22.15% C. 25.05%
B. 24.00% D. 12.70%
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Financing alternative
32. A company has accounts payable of P5 million with terms of 2% discount within 15 days, net
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30 days (2/15 net 30). It can borrow funds from a bank at an annual rate of 12%, or it can wait
until the 30th day when it will receive revenues to cover the payment. If it borrows funds on the
last day of the discount period in order to obtain the discount, its total cost will be
A. P 51,000 less C. P 75,500 less
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B. P100,000 less D. P 24,500 more

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