Optimal Cash Balance
I. THEORY (20 pts.). Select the best possible answer by
making solid marks that fill the response completely. Use
bluepoint pen only. STRICTLY NO ERASURES.
1. Which of the following statements is most correct?
(A) A cash management system that minimizes
collections float and maximizes disbursement float is
better than one with higher collections float and
lower disbursement float. (B) A cash management
system that maximizes collections float and
minimizes disbursement float is better than one with
lower collections float and higher disbursement
float. (C) The use of a lockbox is designed to minimize
cash theft losses. If the cost of the lockbox is less than
theft losses saved, then the lockbox should be
installed. (D) Other things held constant, a firm will
need a smaller line of credit if it can arrange to pay
its bills by the 5th of each month than if its bills come
due uniformly during the month.
2. Which of the following statements is most correct?
(A) A good cash management system would
minimize disbursement float and maximize
collections float. (B) If a firm begins to use a well-
designed lockbox system, this will reduce its
customers' net float. (C) If a firm can get its
customers to permit it to pay by wire transfers rather
than having to write checks, this will increase its net
float and thus reduce its required cash balances.
(D) A firm that has such an efficient cash
management system that it has positive net float can
have a negative checkbook balance at most times
and still not have its checks bounce.
3. Robyn Company is planning to borrow P12,000 from
the bank. The bank offers the choice of a 12%
discount interest loan or a 10.19% add-on, 1-year
installment loan, payable in 4 equal quarterly
payments. What is the approximate (nominal) rate of
interest on the 10.19% add-on loan? (A) 20.38%. (B)
5.10%. (C) 10.19%. (D) 12.00%.
4. If easing a firm's credit policy lengthens the
collection period and results in a worsening of the
aging schedule, then why do firms take such actions?
(A) It normally stimulates sales. (B) To meet
competitive pressures. (C) To increase the firm's
deferral period for payables. (D) Statements A and B
are correct.
5. The Firms generally choose to finance temporary
assets with short-term debt because (A) Matching
the maturities of assets and liabilities reduces risk.
(B) Short-term interest rates have traditionally been
more stable than long-term interest rates. (C) A firm
that borrows heavily long-term is more apt to be
unable to repay the debt than a firm that borrows
heavily short-term. (D) Sales remain constant over
the year, and financing requirements also remain
constant.
6. In the text, the “red-line method” refers to (A) The
policy of drawing a red line around certain
neighborhoods on a map and then refusing to sell on
credit to people who live within those areas. (B)
Restrictions imposed by companies that insure credit
risks. (C) A method of controlling receivables by
drawing a red line on invoices of companies that are
expected to pay late. (D) A method of controlling
inventories by drawing a red line on the inside of a
bin.
7. Which of the following might be attributed to
efficient inventory management? (A) High inventory
turnover ratio. (B) Low incidence of production
schedule disruptions. (C) High total assets turnover.
(D) All of the statements above are correct.
8. Ignoring cost and other effects on the firm, which of
the following measures would tend to reduce the
cash conversion cycle? (A) Maintain the level of
receivables as sales decrease. (B) Buy more raw
materials to take advantage of price breaks. (C) Take
discounts when offered. (D) Forgo discounts that are
currently being taken.
9. Which of the following statements is incorrect about
working capital policy? (A) Holding minimal levels of
inventory can reduce inventory carrying costs and
cannot lead to any adverse effects on profitability.
(B) A company may hold a relatively large amount of
cash if it anticipates uncertain sales levels in the
coming year. (C) Credit policy has an impact on
working capital since it has the potential to influence
sales levels and the speed with which cash is
collected. (D) The cash budget is useful in
determining future financing needs.
10. Which of the following statements is most correct?
(A) Permanent current assets are those current
assets that must be increased when sales increase
during an upswing. (B) Temporary current assets are
those current assets on hand at the low point of the
business cycle. (C) Maturity matching is considered
an aggressive financing policy. (D) None of the
statements above is correct.
11. Which of the following statements concerning
commercial paper is incorrect? (A) Commercial
paper can be issued by virtually any firm so long as it
is willing to pay the going interest rate. (B)
Commercial paper is generally written for terms less
than 270 days. (C) Commercial paper generally
carries an interest rate below the prime rate. (D)
Commercial paper is sold to money market mutual
funds, as well as to other financial institutions and
nonfinancial corporations.
12. Which of the following statements is most correct?
(A) Trade credit is provided to a business only when
purchases are made. (B) Commercial paper is a form
of short-term financing that is primarily used by
large, financially stable companies. (C) Short-term
debt, while often cheaper than long-term debt,
exposes a firm to the potential problems associated
with rolling over loans. (D) All of the statements
above are correct.
 13. Which of the following statements is incorrect? (A)
Commercial paper can be issued by virtually any firm
so long as it is willing to pay the going interest rate.
(B) Accrued liabilities represent a source of free
financing in the sense that no explicit interest is paid
on these funds. (C) A conservative approach to
working capital will result in all permanent assets
being financed using long-term securities. (D) Trade
credit is often the largest source of short-term credit.
14. Which of the following statements is most correct?
(A) Although short-term interest rates have
historically averaged less than long-term rates, the
heavy use of short-term debt is considered to be an
aggressive strategy because of the inherent risks of
using short-term financing. (B) Net working capital
may be defined as current assets minus current
liabilities. Any increase in the current ratio will
automatically lead to an increase in net working
capital. (C) If a company follows a policy of matching
maturities, this means that it matches its use of
common stock with its use of long-term debt as
opposed to short-term debt. (D) All of the
statements above are correct.
15. Which one of the following aspects of banks is
considered most relevant to businesses when
choosing a bank? (A) Loyalty and willingness to
assume lending risks. (B) Competitive cost of services
provided. (C) Experience of personnel. (D) Size of the
bank's deposits.
16. Which of the following statements is (are) true
regarding financial measures? Statement 1. One
disadvantage of using financial measures to evaluate
performance is that they are only available on a
monthly or quarterly basis. Statement 2. One reason
financial measures are used to evaluate performance
is that they are easily quantifiable. (A) Only 1 is true.
(B) Only 2 is true. (C) Both 1 and 2 are true. (D)
Neither 1 nor 2 is true.
17. A description of an organization's values, definition
of its responsibilities to stakeholders, and
identification of its major strategies is called its (A)
Business-level strategy. (B) Mission statement. (C)
Performance objectives. (D) Master budget.
18. A balanced scorecard is a set of (A) Performance
measures. (B) Financial statements. (C) Budget
schedules. (D) Annual reports.
19. In general, a balanced scorecard is used to evaluate
an organization's performance using (A) Standard
costs and variance analysis. (B) Multiple financial and
nonfinancial measures. (C) Financial statements and
ratio analysis. (D) The Board of Director's audit
committee.
20. One of the results in using balanced scorecards is a
shift from a focus on financial results to a focus on
(A) Maximizing market share. (B) Minimizing
budgetary slack. (C) Eliminating fraudulent behavior.
(D) Increasing customer satisfaction.
I. II. Problems (30 pts.). On the worksheet provided, show
your solutions in good accounting form. Encircle final
answers.
1. Robyn Company is evaluating a relaxation of its
credit policy. At present, 70% of sales are on credit
and there is gross margin of 20%. Additional data
are:
Current Anticipated
Sales P500,000 P640,000
Credit Sales P410,000 P520,000
Collection Expenses 3% of credit sales
4% of credit sales
Collection Period 72 days 90 days
Using 360 days in a year, answer the following
questions: (A) What is the change in gross profit
associated with the proposal? (B) What is the
incremental change in collection expenses? (C)
What is the change in average accounts receivable?
(A) P22,000. (B) P8,500. (C) P48,000.
2. Robyn Company carries a part that is popular in the
manufacture of automatic sprayers. Demand for this
part is 4,000 units per year; order costs amount to
P30 per order, and holding costs total P1.50 per unit.
Robyn currently places four orders per year with its
suppliers. Management is considering the
implementation of an economic order quantity
model in an effort to better manage its inventories.
Required:
A. Compute Robyn's economic order quantity.
B. Compute total annual inventory costs if Robyn
follows the EOQ policy.
C. How much will the company save by adopting
the EOQ model?
SOLUTIONS:
A. The EOQ can be figured by taking the square root of:
(2 x annual requirement x cost per order) ÷ annual
holding cost per unit. The square root of (2 x 4,000 x
$30) ÷ $1.50, or 160,000, is 400.
B. The ordering cost is based on 10 orders (4,000 units
÷ 400 units) x $30, and totals $300; the holding cost
is computed on Pullman’s average inventory of 200
units (400 ÷ 2) and amounts to $300 (200 x $1.50).
Thus, costs at the EOQ total $600 ($300 + $300).
Pullman is currently ordering four times each year,
resulting in order costs of $120 ($30 x 4). Each order
is for 1,000 units (4,000 ÷ 4), which gives rise to an
average inventory of 500 units (1,000 ÷ 2) and
holding costs of $750 (500 x $1.50). Total costs are
$870 ($120 + $750), and the EOQ produces a $270
savings for the firm ($870 - $600).
3. Next year Robyn Company expects its gross revenues
from sales to be P80 million. The company’s
treasurer has projected that its marketable securities
portfolio will earn 6.50% over the coming budget
year. What is the value of one day’s float reduction
to the company? Robyn uses a 365-day year in all of
its financial analysis procedures. P 14,247