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B. WORKING CAPITAL MANAGEMENT A. Increase in the ratio of current liabilities to noncurrent liabilities.
B. Increase in the operating cycle.
C. Decrease in the operating cycle.
THEORIES: D. Increase in the ratio of current assets to current liabilities.
Working capital management
1. Working capital management involves investment and financing decisions related to: Moderate
A. plant and equipment and current liabilities. 3. Short-term financing plans with high liquidity have:
B. current assets and capital structure. A. high return and high risk
C. current assets and current liabilities. B. moderate return and moderate risk
D. sales and credit. C. low profit and low risk
D. none of the above
17. The goal of managing working capital, such as inventory, should be to minimize the:
A. costs of carrying inventory Temporary & Permanent working capital
B. opportunity cost of capital 4. Temporary working capital supports
C. aggregate of carrying and shortage costs A. the cash needs of the company. C. acquisition of capital equipment.
D. amount of spoilage or pilferage B. payment of long term debt. D. seasonal peaks.
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Financial Management
(B. Working Capital Management)
D. incurs more shortage costs D. Increases by the number of units of the safety stock.
11. The longer the firm's accounts payable period, the: 19. Which of the following statements is correct for a firm that currently has total costs of carrying
A. longer the firm's cash conversion cycle is. and ordering inventory that are 50% higher than total carrying costs?
B. shorter the firm's inventory period is. A. Current order size is greater than optimal
C. more the delay in the accounts receivable period. B. Current order size is less than optimal
D. less the firm must invest in working capital. C. Per unit carrying costs are too high
D. The optimal order size is currently being used
12. The average length of time a peso is tied up in current asset is called the:
A. net working capital. C. receivables conversion period. Trade credit
B. inventory conversion period. D. cash conversion period. 20. With credit terms of 3/8, n/30, what is the customer’s payment decision date?
A. Three days after the invoice is received.
Receivables management B. The 8th day is the customer’s decision date.
13. All of these factors are used in credit policy administration except: C. Anytime during the period, 8th to the 30th.
A. credit standards C. peso amount of receivables D. The 30th day is the primary decision date.
B. terms of trade D. collection policy
PROBLEMS
14. Which of the following statements is most correct? If a company lowers its DSO, but no Working capital financing
1
changes occur in sales or operating costs, then: . Casie Company turns out 200 calculators a day at a cost of P250 per calculator for materials
A. the company might well end up with a higher debt ratio. and variable conversion cost. It takes the firm 18 days to convert raw materials into
B. the company might well end up with a lower debt ratio. calculator. Casie’s usual credit terms extended to its customers is 30 days, and the firm
C. the company would probably end up with a higher ROE. generally pays its suppliers in 20 days.
D. the company's total asset turnover ratio would probably decline. If the foregoing cycles are constant, what amount of working capital must Casie Company
finance?
15. All but which of the following is considered in determining credit policy? A. P1,400,000 C. P 900,000
A. Credit standards C. Accounts payable deferral period B. P2,400,000 D. P1,800,000
B. Credit limits D. Collection efforts
Cash conversion cycle
2
Inventory management . Luke Company has an inventory conversion period of 60 days, a receivables conversion
16. The use of safety stock by a firm will: period of 45 days, and a payments cycle of 30 days. What is the length of the firm’s cash
A. reduce inventory costs C. have no effect on inventory costs conversion cycle?
B. increase inventory costs D. none of the above A. 90 days C. 54 days
B. 75 days D. 105 days
18. When a specified level of safety stock is carried for an item in inventory, the average
3
inventory level for that item . The Spades Company has an inventory conversion period of 75 days, a receivables
A. decreases by the amount of the safety stock. conversion period of 38 days, and a payable payment period of 30 days. What is the length of
B. is one-half the level of the safety stock. the firm’s cash conversion cycle?
C. Increases by one-half the amount of the safety stock. A. 83 days C. 67 days
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Financial Management
(B. Working Capital Management)
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Financial Management
(B. Working Capital Management)
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period is 45 days, and bad debts are 3 percent of sales. The credit and collection manager . What is the economic order quantity for the following inventory policy: A firm sells 32,000 bags
is considering instituting a stricter collection policy, whereby bad debts would be reduced to of premium sugar per year. The cost per order is P200 and the firm experiences a carrying
1.5 percent of total sales, and the average collection period would fall to 30 days. However, cost of P0.80 per bag.
sales would also fall by an estimated P300,000 annually. Variable costs are 75 percent of A. 2,000 bags C. 8,000 bags
sales and the cost of carrying receivables is 10 percent. Assume a tax rate of 40 percent B. 4,000 bags D. 16,000 bags
and 360 days per year.
What would be the decrease in investment in receivables if the change were made? Annual demand
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A. P 9,688 C. P 96,875 . 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
Total cost to place purchase orders for the year P40,000
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
Sonata Company is considering changing its credit terms from 2/15, net 30 to 3/10, net 30 in What is Marsman’s estimated annual usage in units?
order to speed collections. At present, 40 percent of Sonata Company‘s customers take the 2 A. 1,000,000 C. 500,000
percent discount. Under the new term, discount customers are expected to rise to 50 percent. B. 2,000,000 D. 1,500,000
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 Required annual return on investment
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relaxation of credit standards; therefore bad debt losses are not expected to rise above their . BIBO Company is a distributor of videotapes. Pirate Mart is a local retail outlet which sells
present 2 percent level. However, the more generous cash discount terms are expected to blank and recorded videos. Pirate Mart purchases tapes from BIBO Company at P300.00
increase sales from P2 million to P2.6 million per year. Sonata Company’s variable cost ratio is per tape; tapes are shipped in packages of 20. BIBO Company pays all incoming freight,
75 percent, the interest rate on funds invested in accounts receivable is 9 percent, and the firm’s and Pirate Mart does not inspect the tapes due to BIBO Company's reputation for high
income tax rate is 40 percent. quality. Annual demand is 104,000 tapes at a rate of 4,000 tapes per week. Pirate Mart
earns 20% on its cash investments. The purchase-order lead time is two weeks.
14
. What are the days sales outstanding (DSO) before and after the change of credit policy? The following cost data are available:
A. 27.0 days and 22.5 days, respectively C. 22.5 days and 21.5 days, respectively Relevant ordering costs per purchase order P80 P90.50
B. 22.5 days and 27.0 days, respectively D. 21.5 days and 22.5 days respectively Carrying costs per package per year 3
Relevant insurance, materials handling, breakage, etc., per year 2 P 4.50
What is the required annual return on investment per package?
15
. The incremental carrying cost on receivable is A. P6,000 C. P1,200
A. P 843.75 C. P 643.75 B. P 250 D. P 600
B. P8,889.00 D. P6,667.00
Order quantity
16 20
. The incremental after tax profit from the change in credit terms is . For Raw Material L12, a company maintains a safety stock of 5,000 pounds. Its average
A. P68,493 C. P60,615 inventory (taking into account the safety stock) is 12,000 pounds. What is the apparent order
B. P65,640 D. P57,615 quantity?
A. 18,000 lbs. C. 14,000 lbs.
Inventory management B. 6,000 lbs. D. 24,000 lbs
EOQ
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Financial Management
(B. Working Capital Management)
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Financial Management
(B. Working Capital Management)
Add-on
31
. Perlas Company borrowed from a bank an amount of P1,000,000. The bank charged a 12%
stated rate in an add-on arrangement, payable in 12 equal monthly installments.
A. 22.15% C. 25.05%
B. 24.00% D. 12.70%
Financing alternative
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. A company has accounts payable of P5 million with terms of 2% discount within 15 days, net
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
B. P100,000 less D. P 24,500 more
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. Every 15 days a company receives P10,000 worth of raw materials from its suppliers. The
credit terms for these purchases are 2/10, net 30, and payment is made on the 30th day
after each delivery. Thus, the company is considering a 1-year bank loan for P9,800 (98% of
the invoice amount). If the effective annual interest rate on this loan is 12%, what will be the
net peso savings over the year by borrowing and then taking the discount on the materials?
A. P3,624 C. P4,800
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1
. Answer: A
Daily working capital required: 200 x 250 50,000
Total working capital needed: 28 days x 50,000 1,400,000
CCC = 18 + 30 – 20 28 days
2
. Answer: B
Cash Conversion Cycle = Ave. collection period + Inventory cycle days – Ave. Accounts Payable payment days
Inventory cycle in days 60 days
Average collection period 45 days
Operating cycle 105 days
Deduct Accounts payable payment days 30 days
Cash conversion cycle 75 days
3
. Answer: A
Inventory cycle in days 75 days
Average collection period 38 days
Operating cycle 113 days
Deduct Accounts payable payment days 30 days
Cash conversion cycle 83 days
4
. Answer: D
Inventory conversion period (See #4) 50.0 days
Average collection period (2M/0.1M) 20.0 days
Operating cycle 70.0 days
Less: Ave. Accounts Payable payment days (1.5M/0.5M) 30.0 days
Cash conversion period 40.0 days
5
. Answer: D
Inventory turnover:
Cost of goods sold/Ave. Inventory (8M/1.5M) 5.33x
Inventory conversion period (360 days/5.33) 67.5 days
6
. Answer: A
Annual sales 360 days x 100,000 36.0M
Inventory turnover 36M/5M 7.2x
Inventory conversion period 360/7.2 50.0 days
7
. Answer: B
Optimal cash conversion size = (9,075,000 x 40 / 0.24)^1/2 = 55,000
8
. Answer: B
OTS: (2 x P3,251,250 x P25 ÷ 0.09)^1/2 = P42,500
Opportunity cost: P42,500 ÷ 2 x 0.09 P 1,912.50
9
. Answer: C
Reduction in cash float (2.5 + 1.5) 4.0 days
Additional free cash (4 days x 150 x P500) P300,000
Annual savings (P300,000 x 0.07) P 21,000
10
. Answer: C
Average AR 3,375,000/360 x 30 days 281,250
Average investment: 281,250 x 0.60 168,750
Carrying cost: 168,750 x 0.12 20,250
11
. Answer: B
DSO = (.4 x 10) + (.60 x 45) 31 days
Average AR: 900,000/360x31 days P77,500
12
. Answer: D
Credit sale = 40,500,000 x 80% = 32,400,000
Increased credit sales: 32,400,000 x 1.2 = 38,880,000
New Average AR 38,880,000/360 x 40 = 4,320,000
Old Average AR 32,400,000/360 x 30 = 2,700,000
Increase in Average AR 1,620,000
13
. Answer: C
Change in average accounts receivables:
Planned: 2,200,000/360x30 183,333
Present: 2,500,000/360x45 312,500
Decrease in AR balance 129,667
Variable cost ratio 75%
Decrease in investment in AR 96,875
14
. Answer: A
Days’ sales outstanding
Old policy: (.4 x 15) + (.3 x 30) + (.3 x 40) 27.0 days
New policy (.5 x 10) + (.25 x 30) + (.25 x 40) 22.5 days
15
. Answer: A
Average receivable
New policy: 2.6M/360 x 22.5 162,500
Old policy: 2.0M/360 x 27 150,000
Incremental Accounts Receivable 12,500
Incremental carrying cost on receivable 12,500 x 0.75 x 0.09 843.75
16
. Answer: A
Incremental sales 600,000
Variable cost (.75 x 600,000) ( 450,000)
Additional bad debts (600,000 x 2%) ( 12,000)
Additional carrying cost ( 844)
Additional discounts (2,600,000 x .5 x 03) –(2,000,000 x .4 x .02) ( 23,000)
Before tax increase in income 114,156
Less tax 45,663
Incremental income 68,493
17
. Answer: B
EOQ = (2 x 32,000 x 20 ÷ 0.8)^1/2 = 4,000 bags
18
. Answer: B
Number of orders made 40,000/100 400
Annual requirement 400 x 5,000 2,000,000
19
. Answer: C
Investment in 1 package (20 x P300) P6,000
Required annual return: P6,000 x 0.2 P1,200
20
. Answer: C
Average inventory units 12,000
Less safety units 5,000
Average inventory based on EOQ 7,000
Order size 7,000 x 2 14,000
21
. Answer: D
Safety stockStock out Costs (1)Carrying Costs @
P5Total10010,500500P11,0002004,9001,0005,9003001,7501,5003,2504003502,0002,350
Stockout Costs
100 1750 x .30 x 20 orders = 10,500
200 1750 x .05 x 20 = 4,900
300 1750 x .05 x 20 = 1750
400 1750 x .01 x 20 = 350
Optimal safety stock is 400-unit level with a cost of only P2,350 cost.
22
. Answer: B
The optimal safety stock level represents the level that gives the lowest sum of stock out costs and additional
carrying costs. Based on the computation below, the lowest combined costs is P3,340, corresponding to 300-unit
level
First compute the stockout costs based on given probability of demand. Starting with 100-unit level as safety stock, if
the additional demand is 200, the company has stockout of 100 units.
100: (100 x 32* x 0.25) + (200 x 32 x 0.35) + (300 x 32 x 0.20) + (100 x 9) 4,960
200: (100 x 32 x 0.35) + (200 x 32 x 0.20) + (200 x 9) 4,200
300: (100 x 31 x 0.20) + (300 x 9) 3,340
400: (400 x 9) 3,600
stockout per unit x 8 orders per year.
23
. Answer: A
Ordering costs 4 x P200 800
Carrying costs (50,000 ÷ 2 x 0.75 18,750
Total 19,550
24
. Answer: C
Savings in Expenses/additional Investment in Inventory = Maximum Interest Rate
70,000 / (1,800,000 – 1,000,000) = 8.75%
25
. Answer: C
Number of units to be purchased in advance: 90,000 – 7,500 82,500
Average investments in working capital: 82,500 x 0.5* x P25 1,031,250
Opportunity cost 1,031,250 x 0.12 123,750
*The average investment is one-half (82,500 + 0) ÷ 2
26
. Answer: C
k = (2 ÷ 98) x (360 ÷ 20 = 36.7%
The solution assumes that the company foregoes the discount only once during the year.
27
. Answer: B
With credit terms of 2/10, n/60 one must pay on the 10th day choosing to finance the net payment (invoice price minus
the cash discount) at the rate of 2 percent for 50 days, paying the loan on the 60th day. The annualized rate of foregoing
the discount is 14.9 percent.
k = 2/98 x 365/50 = 14.9%
28
. Answer: B
k = 10 ÷ (100 – 10) = 11.11%
29
. Answer: C
Principal 200,000
Less: Discount 200,000 x 0.15 x 90/360 ( 7,500)
Compensating balance ( 20,000)
Net proceeds 172,500
Effective rate: (7,500/172,500) x 360/90 17.4%
30
. Answer: B
Interest expense 1M x 0.12 120,000
Less interest income on additional CA balance (200,000 x 0.03) 6,000
Net interest cost 114,000
Effective interest rate 114,000/(1,000,000 – 200,000) 14.25%
31
. Answer: A
Interest for 1 year 1M x 12% 120,000
Average Principal: [1M + (1M/12)] ÷ 2 541,667
Estimated effective rate 120,000/541,667 22.15%
Alternative solution for approximate effective rate:
(2 x No. of payments x Interest) ÷ [(1 + No. of payments) x Principal]
(2 x 12 x P120,000) ÷ (13 x P1M) = 22.15%
32
. Answer: C
Discount 5M x 0.02 100,000
Interest (5M x 0.98 x 0.12) x 15/360 = 24,500
Savings = 75,500
33
. Answer: A
Purchase discount 10,000 x 0.02 x 200 purchases 4,800
Interest on borrowed money 9,800 x 0.12 1,176
Savings 3,624
Number of purchases: 360 days/15-day interval 200
34
. Answer: B
The cost of discounts missed is 12.3% which is more than the 8 percent that the bank charges. The company should
borrow on the 10th, pay the invoice, and finance at 8% for the next 30 days (pay off the bank on the 40th).
Cost of foregoing discount: (1 ÷ 99) x (360 ÷ 30) = 12.31%
35
. Answer; B
Net proceeds in pesos P1,500,000
Divided by net proceeds percentage 1.00 – 0.1 – 0.15 0.75
Principal amount P2,000,000