(VISAYAS) Bacolod city (034) 4346214 (MINDANAO) Cagayan Be Dro City (0955) 0570499 * Davao City (082) 2250049 Cebu City (032) 2537900 loc. 218 Pinon weotoemzsowonsseces QPAREVIEW 522459" LECTURE NOTES Working Capital Management A Working Capita Policy Conservative (Relaxed) Policy. The most conservative financing strategy should be to finance all projected funds requirements with fong- term funds and use short-term financing only for ‘emergencies. + Aggressive Policy. This strategy 1s adopted by financing at least a firm's seasonal requirement land possibly some of its permanent requirements, with short-term funds. The balance is financed with long-term funds. + Unlike the aggressive strategy, the conservat strategy requires the firm to pay unneeded funds. The lower cost of the aggressive strategy makes it’ more profitable than the conservative strategy. However, the aggressive strategy involves more risk, Cash and Marketable Securities. Reasons for Holding Cash and Near-Cash Balance: + Transactions balances - Cash balance is mai arder to pay planned expenditures. + Precautionary or Safety Needs ~ Balances are held or temporarily invested in ig that can be Immediately transferred to cash. This balance protects the firm against being unable to pay unexpected expenditures. + Speculative Motive - The balance, oftentimes kept in marketable securities, is Intended for taking advantage of opportunities that may arise. tained in Operating Cycle. The amount of time that elapses from the point when the firm inputs materials and labor inte the production process to the point wtten cesh is coliected from the sale of the finished goods. This consists of two ‘component: + Clearing Float. The delay between the deposit of 3 check by the, payee and the actual availability of the funds. Speeding up Collections Concentration banking. scheme where a firm with numerous sales outlets designate cert offices as collection centers for a given geographic areas. These collection centers deposit the receipts in local banks; in turn, these local banks transfer the funds by wire to @ concentration or disbursing bank. + Lock boxes. Instead of mailing payment to a collection center, the payer sends Itto a past office box that is emptied by the firm’s bank several times dally. The bank deposits the checks in the firm's account and sends to the collecting firm a deposit slip: or computer printout indicating the payments received. + Direct sends. Firms that have received large checks drawn on distant banks or a large number ‘of checks drawn on banks in a given city may ‘arrange to present those checks directly for payment to the bank on which they are drawn, Siowing Down Disbursements + Controlied Disbursing. Involves the strategic use of mailing points and bank accounts to lengthen mail float and clearing float, respectively, + Playing the float a. ‘writing checks against funds that are not currently in the checking accounts, b. staggered funding payable through draft average age of Inventory and the average Optimal Transaction Size. Using the conversion and the collection period of receivables. ‘opportunity costs, the model calculates the economic conversion quantity, the amount (cost-optimizing-quantity) Cash Conversion Cycle. The total number of days in the in whict the firm should convert marketable securities to operating cycle tess the average payment period for cash ff cash to marketable securities. materials. os = PEK Conversion Cost x Annual Demand Tor Improving Cash Conversion Cycle: Cash / Opportunity Cost (in decimat) + Turnover inventory as quickly as possible, avoiding stockouts that might result in.a loss of sale. + Collect accounts receivable as quickly as possinie. + Pay accounts payable as late 2s possible without damaging the firm’s credit rating, but take advantage of any favorable cash discounts. Cash Management Techniques 1. Flcat, Funds that have been tendered or dispatched by a payer but are not yet in a form that can be spent by the payee, Float may either be collection float or disbursement float, Net float is the difference between the two types of float, Conversion cost - the cost of converting marketable securities to cash, It includes the fixed cost of placing an erder for cash or marketable securities, paperwork costs, brokerage fees, and cost of any follow-up action. Opportunity cast - the cost of holding cash rather than marketable securities (rate of interest that can be earned on marketable securities ‘Total Cost of Cash = (Cost per conversion x number of conversion) .+ (@pportunity cost x Average cash boalence) Components of Float: Accounts Receivable + Mail Float ~ The delay between the time when 4 _ Components of Accounts Receivable Management payer mails 2 payment and, the time when the payee receives it + Processing Float. The delay between the receipt of ~areneck and its deposit in the firm’s account... Credit Policy or Standards + Determine credit selection + Creait stangards + --€vedit terms, Page 1 of 11 www.prtc.com.ph . MAS.2313— en Collection Poticy Key Variables of Changing Credit Standards Sales volume Investment in accounts receivable Bad debt expenses. Terms of Trade 3 Cost of Marginal Investment in Accounts Receivable Ave. Investment in = Accounts Receivable Total variable cost of annual sales Turnover of Accounts Receivable Cost of Marginal Investment = Marginal Investment in ‘AR x Required Return ‘on Investment in Accounts Receivable Cost of Marginal Bad Debts = Bad Debts under proposed plan ~ Bad Debts under present plan Inventory Management 1, The ABC System, Inventory is divided into three categories of descending importance based on the ‘peso investment in each, Economic Order Quantity (EOQ) Model. Inventory management technique for determining an. item's ‘optimal order quantity, which is the one that minimizes, the total of its order and carrying costs. a) Order costs - Fixed clerical costs of placing and receiving an order. b) Carrying costs ~ Variable costs per unit of holding an item in inventory for a specified time period; include storage, insurance, deterioration and ‘obsolescence, opportunity costs of tying up funds in inventory. Inventory Costs = (Ordering Cost x Number of order per year) + (Order size/2 + safety stock) x Carrying cost per unit 4) Formula: £0Q = 72x Annial Demand x Ordering cost / Carrying Cost per unit ° Short Term Financing 1. Accounts Payable. This is the major source of, unsecured short-term financing. a. Credit terms; + Credit period Cash discount Cash discount period ‘Analysis of Credit Terms: Taking the cash discount. If Cash discount is to be taken, a firm should pay on the last day of the discount period: Giving up cash discount. If the firm has to give up cash discount, it should pay on the last day of the credit period. Cost of giving up a cash discount [CD / (100% - CD)] x (360 / N) where: CD = Cash discount percentage N= Number of days payment can be delayed by giving up the cash discount The formule above assumes that 2 firm gives up only one discount during the year. Ifa firm continually gives up the discount during the year, the annualized cost is calculated: [1 + (CD/100%-cD)}>*™ ~ 1 Stretching Accounts Payabie. A firm should pay the bills as late as possible without damaging its credit rating. This strategy reduces the cost of giving up a discount. When a firm can stretch the payment of accounts payable, the cost of foregoing the discount can be lowered, 2. Bank Loans 1. Single-payment Notes. If the interest is payable upon maturity, the effective interest rate is equal to the nominal rate. 2, Discounted Note. The effective interest rate is higher than the nominai rate. Effective Rate = [Interest / (Principal Amount ~ Discounted Interest)] If the term is less than a year, the interest rate is annualized. 3. Compensating Balance. An arrangement whereby a borrower is required to maintain certain percentage of amount borrowed as compensating balance in the current account of the borrower. Problem 2, Colt Stee! nos Ghefeo,a00 in assets: Temporary current assets 2,000,000 Permanent current assets 4,000,000 Fixed assets, 1,800,000 Total assets 7,800,000 Short-term rates are 6 percent. Long-term rates are 10 percent. Earnings before interest and taxes are 2,000,000. The tax rate is 40 percent, Required: 1 If long-term financing is perfectly. matched (synchronized) with long-term asset needs, and the same is true of short-term financing, what will earnings after taxes be? Colt wishes to finance all fixed assets and half of its permanent current assets with long-term financing costing. Determine Colt's earnings after taxes under this financing plan. As an alternative, Colt might wish to finance all fixed assets and’ permanent current assets plus half of its temporary current assets with long-term financing. What will be Colt's earnings after taxes? For question number 2 & 3, assume the term structure of interest rates becomes inverted, with short-term rates going to 12 percent and ‘long: term rates 7.5 percentage points. If all other factors in the problem remain unchanged, what will earnings after taxes be? MULTIPLE CHOICE 1. Seasonal peaks in business are supported b) permanent working capital ong-term financing temporary financing discretionary financing 2. An aggressive working capital policy would include: ja. using short term financing to finance only the peak temporary working capital Using short term financing to finance all temporary working capital using short term financing to finance ail temporary and some permanent working capital both 2, and 5. above describe aggressive working capital policies »,Temporary financing is ‘a. the seasonal borrowing capacity of a firm b. incremental working capital necessary to finance slower than expected collections of customer receivables incremental temporary working capital necessary to support peak activity in seasonal 4. additional payroll cost and expenses incurred during seasonal peaks Which of the following Is an acceptable financing wisdom? a. The maturity of funds used to support a project should roughly match the project's duration, b. Because firms can use their own equity as they choose, equity can be used to finance projects of any duration. ‘c. Any project can appropriately be supported by funding with a shorter maturity 4d. Any project can appropriately be supported by funding with a longer maturity Which of the following working capital financing policies subjects the firm to the greatest risk? 2. financing temporary working capital with long- term debt b. financing permanent working capital with tong- term debt c. financing permanent working capital with short- term debt 4. financing temporary working capital with short- term debt {A firm following an aggressive approach to working capital policy will finance all of the fixed assets with “ "and some of the firm's permanent current assets will be financed with a. short-term nonspontaneous sources of funds; long term capital b. commercial paper; long term capital long term-capital; short-term nonspontaneous sources of funds d. long term capital; corporate bonds |. The aggressive approach towards working capital policy requires the use of short-term debt, whereas the Conservative approach of working capital policy requires the _____. use of short: term debt. a, greatest; least b. least; greatest a cc. limited; total 4. lack of; heavy Firms generally choose to finance temporary current assets with short-term debt because 3. matching the maturities of assets, and liabilities reduces risk under some circumstances, and also because short-term debt Is often less expensive than long-term capital. . b. short-term interest rates have traditionally been ‘more stable than long-term interest rates. c. a firm that borrows heavily on a long-term basis is more apt to be unable to repay the debt then a firm that borrows short term. d, short-term debt has a higher cost than equity capital. Which of the following best describes temporary financing? a. incremental working capital to finance accounts receivable that are higher than expected. 10, b. incremental temporary financing to fund high seasonal production levels, c. incremental working capital to finance an unplanned bargained purchase. d. none of the above describes temporary financing. Supporting working capital with tong term financing Is a. risky but Inexpensive b. conservative but expensive ©. expensive and risky d. conservative and inexpensive Problem 2. Universal Insurance Company has collection Problem 3. ‘centers across the country to speed up collections. The company also makes its disbursements from remote disbursement centers so checks written by Universal Insurance take longer to clear the bank. Collection time has been reduced by three Md disbursement time increased by two days because of these policies. Excess funds are being invested in short-term instruments yielding 8 percent per annum. a, If Universal Insurance has P4.5 million per day in cotiections and P25 milion per day in disbursements, how many pesos has the cash management SystenGees . How much can UnivergP"Tistrance earn in pesos per year on short-term investments made possible by, the freed-up cash? Apo Company uses a continuous billing system that results in average dally receipts of 450,000. The company treasurer estimates that @ proposed lock-box system could reduce Its collection time by 4 days. 1. How much cash would the lock-box system free up for the company? 2. What is the maximum amount that Apo Company wouid be willing to pay for the lock-box system if it can earn’6 percent on available short-term funds? MULTIPLE CHOICE 1 2 3. Collection float: a, is more desirable to firms than disbursement float. b. is fully eliminated by the installation of a lotkbox system, exists when a firm's available balance exceeds book balance. 6. can be eliminated if all received electronically, collections could be Net Moat: a. that Is negative indicates a firm has written checks that have not cleared the bank b. that is positive indicates that collection float exceeds disbursements float. cis equal to collection float minus disbursement float, d. is equal to the available balance minus the book balance. A lockbox system: ‘@. entails the use of a bank which is centrally located to collect payments on a nationwide basis. deposits customer checks prior to recording customer payments to their respective receivable accounts, c. is used to reduce the disbursement float of a firm.Problem 4. 4d. Is efficient irregardless of the locations selected for lockbox destinations. Lockboxes: a. should be geographically located close to a firm's primary customers. b. Should be located in remote locations to increase the net disbursement float. c. offer no additional benefit to a firm now that the Check Clearing Act for the 21* Century has been enacted. . tend to be negative net present value projects for firms with @ large number of sizeable transactions, A cash concentration account: 2. is frequently used as a source of funds for short- term investments. b. cannot be used to cover @ compensating balance requirement. c. cannot be used to transfer balance accounts. d. is managed by the credit manager of a firm, funds into zero The main purpose of a cash concentration account is to: a. decrease collection float. b.. decrease disbursement float. ¢. consolidate funds. d. replace a lockbox system. ‘A lockbox plan is a, used to protect cash, i.e.,.to keep it from being stolen bused to Identify Inventofy safety stocks €. used to slow down the collection of checks our firm writes. d. used to speed up received. the collection of checks A lockbox plan is most beneficial to firms that a. have suppliers who operate in many different parts of the country. b. have widely dispersed manufacturing facilities. ©. have a large marketable securities portfolio, and cash, to protect. d, have customers who operate in many different parts of the country. Mayon Company estimates its total cash outlays at P15 million during the coming year. The company normally spends P45 to transfer cash from marketable secutities to cash in bank and vice versa, The marketable securities portfolio currently earns an 6% annual rate of return, Compute the folowing: ‘Compute the optimal transaction size 2. Compute the sverage cash balance 3. Compute the total annual cost of cash if the company adopts the optimal transaction size. 4, What’ are the minimum and maximum balances, cash Problem 5, Banahaw, Inc. currently has sales of P25.0 million. Its credit period and days sales outstanding (080) are both 30 days, and 2.0 percent of its sales fend up as bad debts. the credit manager estimates that, ifthe firm extends its credit period to 50 days so that Its days sales outstanding increases to 40 days, sales will increase by 5.0 million, but their bad debt losses on the incremental sale3 would be 3.0 percent. Variable costs are 70 percent, and the cost of carrying receivables, k, is 10 percent. Assume a tax rate of 40 percent and 360 days per years Poy wip in 1. Compute the incrementaf investment ‘required to finance the increase in receivables if the change is implemented 2. What: would be the incremental cost of cartying receivables? 3. What would be the effect of those changes in net income? Problem 6. Mercado Company has sales of P12 milion, Its credit period and average collection period are both 30 days, and 1.5% of its sales end as bad debts. The manager intends to extend the credit term to 40 days which will increase sales to P15 million. However, bad debt losses on ail sales would be 2.5%. Costs'of products and related expenses amount to 60%, exclusive of the cost of carrying receivables of 9% and bad debt expenses, Assuming 360 days a year, what incremental cost of Investment is required to support the change in policy? Problem 7. Angelica Company sells on terms of 2/10, net 30." Total sales for the year are 1,200,000. Forty: five percent of the customers pay on'the 10® day and take’ the discounts; the other 55 percent pay, on average, 40 days after their purchases. Assume’ 360, days per year ak Babe eath 1. What is the days sales outstérsing? 2! What is the average amount of receivables? 3. What would happen to average receivables if Angelica toughened up on its collection policy with the result that all non-discount customers paid on the 30" day? MULTIPLE CHOICE 1 Which of the following credit and. collections decisions would typically not increase the accounts receivable balance? a. extending credit to less creditworthy customers b. increasing the discount offered for prompt payment c extending the time allowed for payment of a customer's bill d. delaying dunging department cick? letters from the éredit Relaxation of credit policy results in ‘an increase in credit sales. a decrease in credit expenses, {a decrease in investment in receivables. bandc The effect of a-change in a firm's credit terms from "net 30" to "G/yb, net 30” on its own balance sheet 5 Likely to BE ASF Bree gi #2 range meabeat a. decreased accounts receivable, b. increased accounts receivable ©. decreased accounts payable. d. increased accounts payable ‘The conditions under which a firm sells its goods and services for cash or credit are called the: a. terms of sale b. credit analysis. ._ collection policy. 6. payables policy. The process of determining the likelihood that customers will not pay is called a. the terms of sale. b. ‘creait analysis orangthe coltection policy. Should the company go ahead and switch to level d. the payables. policy, 6. Which one of the following wilt increase a, firm's Investment in accounts receivables? . a. a decrease in the number of days for which credit is granted b. a decrease in credit sales ., an increase in average daily credit sales d. a decrease in the average collection period 7. Which one of the following factors tends to favor longer credit periods? 2. high consumer demand b. lower priced merchandise c. merchandise with low collateral value d. increased competition = pe = ¢ 8. Which one of the following statements’ Is “correct concerning credit periods? a Perishable items tend to have periods, b. Items with low markups tend to have jonger credit perioss. ‘Smaller accounts tend to have longer credit longer credit, periods d. A firm: may offer different credit terms to different customers. 9. When credit policy is at the optimal point, the 2. total costs of granting credit will be maximized b. carrying costs of credit will be equal to zero, ©. opportunity cost of credit will be equal to zero. 4. carrying costs will equalthe opportunity costs. Problem 8. Nowlin Pipe & Steel has projected sales of 72,000 pipes this year, an ordering cost of PS per ‘order, and carrying costs of P2.40 per pipe. 4. What is the economic ordering quantity? b. How many orders will be placed during the year? What will the average inventory be? Problem 9. Howe Corporation Is trying to improve its inventory control system and has installed an on-line computer at its retail stores. Howe anticipates sales of 126,000 units per year, an’ ordering cost of P4 per order, and carrying costs of P1,008 per unit. 1. What is the economic ordering quantity? 2. How many ordersenill be placed during the year? 3. What will the average inventory be? 4. What is the total cost of inventory expected to be? Problem 10. . Higgins Athletic Wear has expected sales of 22,500 units a year, carrying costs of P1.50 per unit, and an ordering cost of P3 per order. 4. What is the economic order quantity? 2. What will be the average inventory? The total carrying cost? 3. Assume an additional 120 units of inventory will be required as safety stock. What will the new average inventory be? What will the new total carrying cost be? Problem 12. Dimagglo Sports Equipment, Inc., is considering a switch to level production. Cost efficiencies will occur under level. production and aftertax costs would decline by P35,000, but inventory costs would increase by P400,000. Dimaggio would hhave to finance the.extra inventory at a cost of 10.5 percent. Problem 16. production? 2. How low would interest rates need to fall before level production would be feasible? Problem 12. Coie Manufacturing turns over its inventory 5 times each year, has an average payment period of 30 days, and has an average collection period of 50 days. The firm's total annual outlays for operating- cycle investments are P24 million. Assume a 360 day- year. Sa Rest ege Be DR a Calculate the firm's dperating and cash conversion cycles. b, Ceiculate the firm’s dally cash operating expenditure. How much in resources must be invested to support its cash conversion cycle? c. If the firm's pays 9% for these resources, by how much would it change its annual profits by favorably changing its current cash conversion cycle by 10 days? Problem 13. Compute the approximate and the effective annual cost of foregoing the cash discount for each of the following: Supplier 3/10 net so 48 Fa! “94 Supplier 3/15 ret 40 Supplier © 2/10 net 60 ‘Assuming that the firm needs short-term financing, recommend whether it would be better to give up the cash discount or take the discount and borrow from a bank at 20% annual interest. Evaluate ‘each supplier separately. Problem 14. Solar Company Is going to borrow P3 million for one year at 8 percent interest. what is the effective rate of interest ifthe loan is discounted? Problem 15. Parumeg Company is negotiating with the Sierra ‘Madre Genk for'a Teves 95 lion lose The bank has afered the Ceenpony the folooans foun wih 2 45 parent compeisetion: Uaarce wih a 20 percent sazcesaing balsas, Inctatene es oe antoyns 5. A's percent add-on TORY pean ule Banoy Corporation, needs to raise 1,200,000 for 1 year to supply working capital to a ew store. Banoy buys from its suppliers on terms of 2/20, net 45, and it currently pays on the 10" day and takes discounts, but it could forgo discounts, pay on the 45" day, and get the needed P200,000 in the form of costly trade credit. Alternatively, Banoy could borrow from its bank on a nine péscent discount interest rate basis. What Is tive annual interest rate of the lower-cost source? Problem 47. Care Centers, Inc., plans to borrow 800,000 for one year at 10 percent from the Luzon Bank’ and Trust Company. There is a 20 percentcompensating balance requirement. Care keeps minimum transaction balances of P50,000 in the normal course of business, toward meeting the requirement. 2. What is the effective rate of interest? b. Assuming that the deposit with the bank earns a 2 percent interest, recalculate the effective interest rate, This idle ‘cash counts ‘compensating balance Problem 18. The Friendly Bank offers AB United 2 2,000,000 tine of credit with an interest rate of 2.5 percent per quarter. The credit line also requires that 20 percent of the unused portion of the credit line be deposited in a non-interest bearing account as 8 compensating balance. AB United's short-term investments are paying 2.0 percent per quarter. Assume any funds borrowed or. invested use compound interest, ‘A. What is the effective annual interest rate on this “arrangement if the line of credit goes unused all year? B. What Is the effective annual interest rate on the line of credit if a customer borrows the entire 2,000,000 for one year? Problem 19. Quickie Loans Inc. offers you “three for, four or I knock on your door." This means you get P3 today and repay P4 when you get your salary in cone week (or else). What is the effective annual return Quickie earns on this lending business? Recalculate the effective interest rate if the term is “four for three or I know on your door.” Fir lv INVESTMENT BANKING TD watts Problem 1. Mindanao Timber Company currently has 5 million shares of stock outstanding and will report earnings of 9 million in the current year. The company is considering the Issuance of 1 million additional shares that will net P40 per share to the ‘corporation, 2. What is the immediate dilution potential for this new stock issue? b. Assume the Mindanao Timber Company can earn LL percent on the proceeds of the stock issue in time to include it in the current: year’s results. Should the new issue be undertaken based on ‘earnings per share? c. If the i million additional shares can only be issued at P32 per share and the company can earn 5 percent on the proceeds, should the new issue be Undertaken based on earnings per share? Problem 3, Winston Sporting Goods is considering @ public offering of common stock, .Jts investment banker has informed the company that the retail price will be P18 per share for 600,000 shares. The Company will receive P16.50 per share and will incur 150,000 in registration, accounting, end printing fees. ‘a. What is the spread on this issue in percentage terms? What are the total expenses of the issue as 2 percentage of total value (at retail)? b. If the firm wanted to net P18 million from this issue, how many shares must be sold? Problem 3. Kevin's Bronze Company has earnings of P6.5 ‘milion with 2 million shares outstanding before a public distribution, Five hundred thousand shares will be included in the sale, of which 300,000°are new corporate shares and 200,000 are shares currently ‘owned by Ann Fry, the founder and CEO. The 200,000 shares that Ann is selling are referred to as @ secondary offering and all proceeds will go to her. The net price from the offering will be P15.50 and the corporate proceeds are expected to produce 1.5 million in corporate earnings. 3) What were the corporation's earnings per share before the offering? What are the corporation's earnings per share expected to be after the offering? >) Problem 4. Walton & Company Is the managing Investment banker for a major new underwriting. The price of the stock to the investment banker is P17 per share. Other syndicate members may buy the Stock for P18.25. The price to the selected dealers group is P18.80, with a price to brokers of 19.20. The price to the public is P19.50, a. if Walton & Company sells its shares to the dealer group, what will be the percentage return? b. If Walton & Company performs the dealer's function also and sells to brokers, what will be the percentage return? cf Walton & Company fully integrates its oferation and sells directly to the public, what will be the percentage return? Problem 5, Wonder Drug Co. has a net income of P16, million and 5 million shares. outstanding, Its common stock is currently selling for P35 per share, Wonder plans to sell common stock to” set up a major new production facility with a net cost of P21,660,000. The production facility will not produce a profit for one year, and then it Is expected to earn a 15 percent return on the investment. Stanley Morgan & Co., an investment banking firm, plans to sell the issue to the public for P30 per share with a spread of 5 percent. , How many shares of stock must be sold to net 21,660,000? b. Why is the investment banker selling the stock aty. Jess than its current market price? ba aibest int c, What are the earnings per share (EPS) and thepew) price-earnings ratio before the issue (based on sa Stock price of P40)? What will be the price perty share immediately after the sale of stock if the P/E stays constant? d. Compute the EPS and the price (P/E stays constant) after the new production facility begins to produce a profit. Problem 6. The Spears Corporation is about to go public. Tt currently has after-tax earnings of PS million and 3 million shares are owned by the present stockholders (the Spears family). The new public issue will represent 500,000 new shares. The new shares will De priced to the public at P15 per share, with a 4 percent ‘Spread on the offering price, There will also be P160,000 in out-of-pocket costs to the corporation. 3. Compute the net proceeds to the Speers Corporation. b. Compute the earnings per share immediately before the stock issue. Compute the earnings per share immediately after the stock issue. de Determine what rate of return must be earned on the net proceeds to the corporation so there will not be a dilution in earnings per share during the year of going public e. Determine what rate of return must be earned on the proceeds to the corporation so there will be a 5 percent increase in earnings per share during the year of going public. +Ne — | MULTIPLE CHOICE 1 A lockbox plan is, a. used to protect cash, Le. stolen 'b. used to identify inventory safety stocks. . used to slow down the collection of checks our firm writes. d. used to speed up the collection of checks received. to keep it from being Which of the following statements is CORRECT? a. Net working capital is defined as current assets minus the sum of payables and accruals, and any increase in the current ratio automatically indicates that net working capital has increased, b. Although short-term interest rates have historically averaged Jess than long-term rates, the heavy use of short-term debt is considered to be an aggressive strategy because of the inherent risks associated with using short-term financing. €. If a company follows a policy of “matching maturities," this means that it matches ifs use of common stock with its use of long-term debt as ‘opposed to short-term debt. d. Net working capital is defined as current assets minus the: sum.of payables and accruals, and ‘any decrease in the current ratio automatically indicates that net working capital has decreased. Which of the following actions would be tikely to shorten the cash conversion cycle? 2. Adopt @ new manufacturing process that speeds up the conversion of raw materials to finished ‘goods from 20 days to 10 days. b. Change the credit terms offered to customers from 3/10, net 30 to 1/10, net 50. . Adopt a new manufacturing process that saves some labor costs. but slows down the conversion of raw materials to finished goods from 10 days to 20 days. 4. Change the credit terms offered to customers from 2/10, net 30 to 1/10, net 60. Which of the following is NOT a situation that might lead a firm to increase its holdings of short-term marketable securities? a. The firm must make a known future payment, such as paying for a new plant that is under construction, b. The firm is going from its peak sales season to its slack season, so its receivables and inventories will experience a seasonal decline. The firm is going from its slack season to its peak sales season, so its receivables and inventories wili experience seasonal increases. . The firm has just sold long-term securities and hhas not yet invested the proceeds in operating assets. Which of the following statements is most consistent with efficient Inventory management? The firm has a a. below average inventory turnover ratio. b. low incidence of production schedule disruptions. ¢. below average total assets turnover ratio. 4. relatively high current ratio. 6, 20. Which of the following statements is CORRECT? 2. Other things heid constant, the higher @ firm's days sales outstanding (DSO), the better its credit department. b. Ifa firm that selis 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. c. Ifa 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. Ifa firm sells on ternis of net 60, and if 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. Which of the following statements is CORRECT? a, Trade credit is provided only to relatively large, strong firms. b. Commercial paper is a: form of short-term financing that is primarily used by large, strong, financially stable companies. * c. Short-term debt is favored by firms because, while it is generally more expensive than long- term debt, it exposes the borrowing firm to less risk than long-term debt, d. Commercial paper can be issued by virtually any. firm so. long as it is willing to pay the going interest rate, Which of the following statements is NOT CORRECT? a. Commercial paper can be issued by virtually any firm so long as it is willing to pay the going interest rate, Accruals are “free” in the sense that no explicit interest is paid on these funds. cA conservative approach to working capital management will result in most if not all permanent assets being financed with long-term capital. . d. The risk to a firm that borrows with short-term credit is usually greater than if it borrowed using long-term debt. This added risk stems from the greater variability of interest costs on short-term debt and possible difficulties with rolling over short-term debt. @. Bank loans generally carry a higher interest rate than commercial paper, Cass & Company has the following data, What is the firm's cash conversion cycle? Inventory Conversion Period = 48 days Receivables Collection Period = 17 days Payables Deferral Period = 25 days. 3. 42 days b. 33 days c. 35 days d. 40 days Dy! Pickle Inc. had credit sales of P3,606,000 last year and its days sales outstanding wes 0SO = 35 days. What was its average receivables balance, based on a 365-day year, . 407,342 362,466 300,329 345,205 s da eT a 1" 12 13 414. 45. 16. 17 18. Edwards Enterprises follows a moderate current ‘asset investment policy, but it is now considering change, perhaps to a restricted or maybe to a relaxed policy. The firm’s annual sales are 400,000; its fixed assets are P100,000; its target capital structure calls for 50% debt and 50% equity; its EBIT is P39,000; the interest rate on its debt is 10%; and its tax rate Is 40%. With a restricted policy, current assets will be 15% of sales, while Under @ relaxed policy they will be 25% of sales. What is the difference In the projected ROES between the restricted and relaxed policies? 2. 6.84% . 5.85% b. 5.97% d, 6.49% Atlanta Cement, Inc, buys on terms of 2/15, net 30. It does not take discounts, and it typically pays 115 days after the invoice date. Net purchases amount to P720,000 per year. What is the nominal_annual percentage cost of its non-free trade credit, based on a 365-day year? a. 7.15% b. 7.45% c. 9.31% d. 7.60% Buskirk Construction buys on terms of 2/15, net 60 days, It does not take discounts, and it typically pays on time, 60 days after the invoice date. Net purchases amount to 650,000 per year. On average, how much “free” trade credit does the firm Feceive during the year? (Assume a 365-day year, ‘and note that purchases are net of discounts.) a, P31,253 c. P31,788 b. 27,781 od. P26,712 Affleck Inc.'s business is booming, and it needs to raise more capital. The company purchases supplies on terms of 1/10, net 20, and it currently takes the discount. One way of getting the needed funds would be to forgo the discount, and the firm's owner believes che could delay payment to 90 days without adverse effects. What would be the effective annual percentage cost of funds raised by this action? (Assume a 365-day year.) 2. 3.85% c. 4.69% b. 4.93% ei 5.54% Jefferson City Computers has developed a forecasting model to estimate its AFN for the upcoming year. All ‘else being equal, which of the following factors is most likely to lead to an increase of the additional funds needed (AFN)? ‘A sharp Increase in its forecasted sales. {A sharp reduction in its forecasted sales. ‘The company reduces its dividend payout ratio. ‘The company switches its materials purchases to a supplier that sells on terms of 1/5, net 90, from a supplier whose terms are 3/15, net 35. ‘A firm buys on terms of 2/10, net 30, but generally does not pay until 40 days after the invoice dete. Its purchases total P1,080,000 per year. How much “non-free” trede credit does the firm use on average each year? 2. P120,000 c. P90,000 b. P60,000 ¢. P30,000 Refer to item no. 16. What is approximate cost of the “non-free” trade credit? 2, 16.2% c. 19.4% b. 21.9% 0. 24.5% Gees Pipelines, Inc., has developed plans for new pump that will allow more economical operation of the company’s oll pipelines. Management estimates that P2,400,000 will be required to put this new pump into operation. Funds can be obtained from a bank at 10 percent discount interest, or the company can finance the expansion by delaying to payment to its suppliers: Presently, Gees purchases under terms of 2/10, net 40, but management believes payment could be delayed 30 additional days without penalty; that is, payment could be made in 70 days. Which means of financing should Gees use? (Use the approximate cost of trade creait.) fa. Trade credit, since the cost is about 12.24 percent. b. Trade credit, since the cost is about 3.13 percentage points less than the bank loan. c. Bank loan, since the cost is about 1.13 percent points less than trade credit. d, Bank loan, since the cost Is about 3.13 percentage points less than trade credit. USE THE FOLLOWING FOR NUMBER 19 THROUGH 21. You plan to borrow P100,000 from your bank, which offers to lend you the money at a 15 percent nominal, or stated, rate on a 1-year loan. 19, What “Is the effective interest rate if the loan is discount loan? a. 17.65% b. 17.50% . 15.00% 4. 30,00% 20. What is the approximate effective interest rate if the loan is an add-on interest loan with 12 monthly payments? 2. 17.65% ¢, 15.00% b. 20.00% 4. 26.50% 21. What is the effective interest rate if the loan is a discount loan with a 10 percent compensating balance? a. 17.65% ©. 20,00% b. 17.50% 4. 26.50% 22. Roma Company obtained @ short-term bank loan for P1,000,000 at an annual interest rate 12%. AS a condition of the loan Roma required to maintain a compensating balance of P200,000 In Its checking account. The checking account earns interest at an ‘annual rate of 6%, Roman would otherwise maintain only P100,000 in its checking account for transactional purposes, Roma's effective interest costs of the loan is a. 12% « c. 13.50% 14.00% d. 12.67% 23, Lion Co. can issue three-month. commercial paper with a face value of P1,000,000 for P980,000. Transaction costs would be P1,200, The annualized percentage cost of the financing would be a, 2.17% ¢. 8.48% be 8.67% J, 8.00% 24. The Meng Corp, was recently quoted terms on a commercial bank loan of 7 percent discounted interest with a 20 percent compensating balance. ‘The term of the loan is one year. The effective cost of borrowing is (rounded to the nearest. hundredth) a. 6.54% ©. 8.75% b. 9.41% . 9.59% 25. Mary Company has an inventory conversion period of 45 days, a receivables conversion period of 30 days, and a payments cycle of 24 days. What is the length of the firm’s cash conversion cycle? — TTTa. 51 days ©. 75 days b. 54 days d. 99 days 26. Refer to item no. 25. If Mary's sales are 972,000 annually, what is the firm’s balance in accounts receivables? a. P72,450 c. 979,090 b. PBS,300 . P81,000 Use the following for number 27 & 28. Josie Company sells on terms of 3/10, net 30. Gross sales for the year are P1,200,000 and the collections department estimates that 30 percent of the customers pay on the tenth day and take discounts; 40 percent pay on the thirtieth day; and the remaining 30 percent pey, on average, 40 days after the purchase, Assume 360 days per year. 27. What is the average collection period? 3. 10days| c. 13 days b. 20 days 4. 27 days 28. What is the current receivables balance? a. P60,000 . P75,000 b. P80,000, 4. 90,000 29. The average daily remittances are PS milion, and “extended disbursement float” adas 3 days to the disbursement schedule, how much should the firm be willing the pay for a cash management system if the firm earns 10% on excess funds. a. P500,000 — c. P1,500,000, b. P1,000,000 d. PO 30. Working capital policy involves a tradeoff between easier operation and __ a. more working capital b. spontaneous liabilities temporary financing d._ the cost of carrying short-term assets 31. Forming working capital policy Involves a series of a, profit-risk tradeoffs. b. financial choices . €. capital budgeting decisions 4d. none of the above 32. Which of the financing? a. the origination of @ 9-month bank loan. b. the'issuance of a note payable with a maturity of, less than one year ©. an increase accounts payable resulting from the Purchase of inventories on 30-day credit a. aande following represents spontaneous 33. Short-term foans are generally used to finance permanent additions to working capital finance additions to fixed assets. finance seasonal working-capital requirements. retire equity, thus changing @ firm’s capital structure, 34, The speculative motive is the need to hold cash: a. to pay outstanding checks. b. to‘maintain a firm's daily operations. to invest in opportunities which may arise. 4d. to compensate a bank for services rendered. 35. The need to hold cash as @ safety margin to act as a financial reserve Is calied the ____ motive. 3. speculative «. transaction b. precautionary d. float 36, 37. 38, 39. 40. 41, 42. 43. 44, a: ‘The practice of and procedures for moving cash from multiple banks into @ firm's centralized bank account is known as: a. cash concentration, b._ strategic cash disbursement, ©. transfer flotation. d. float management, An account into which funds are deposited only in an amount equal to the value of the checks presented for payment that day is called a account. lockbox concentration zero-balance compensating balance A zero balance account: a. IS used to cover the compensating balance requirement of a line of credit agreement. b. is only used to deposit funds received at local lockboxes. ¢. is funded on an as-needed basis only. 4. is limited to handling payroll disbursements. Your company has an available balance of P5,980, A deposit of Pi,470 that was made this morning is not yet included in the bank's balance. There are also 2 checks outstanding with 2 vaiue of P495 each. What is the net float? a. net coliection float of P480 b. net collection float of P975 cnet float of PO 4. net disbursement float of P4830 * ‘The basic evidence of indebtedness is called the a. account document, b. sales draft credit instrument. ©. commercial paper A captive finance company is a: 2. wholly-owned subsidiary that handles the credit Tunction for the parent firm, b. wholly-owned subsidiary which handles all the long-term debt obligations of the parent firm. .foan company which provides financing strictly to @ particular industry, such as retail furniture stores @. consumer loan company which operates in one clearly defined and limited geographic area. The basic factors to be evaluated in the credit evaluation process, the five Cs of credit, are: a. conditions, control, cessation, capital, and capacity. b. conditions, character, capital, control, and capacity, ©. capital, collateral, control, character, and capacity, d. character, capacity, capital, collateral, and conditions. What is the process of quantifying the likelihood of default when granting consumer credit called? a. credit scoring b. credit capacity receipts assessment 4d. conditions for crecit What is the restocking quantity that minimizes a firm's total inventory cost called? a, short order quantity b. economic order quantity Bane OnF TT ad eae eee oe PICT62 63. 64 65. 66. 67 68, 69 If the prompt payment discount is foregone, which of the following credit terms implies the customer is borrowing at a rate that is less than 20% (assure 365 days per year)? 3. 2/10, net 30 b. 41.5/10, net 30 ©. 1/10, net 20 d. 8/20, net 75 CNN Corporation needs P750,000 and plans to borrow from its bank under the terms of Its line-of-credit arrangement. These terms call for a minimum compensating balance of 12 percent. How much will CNN have to borrow to obtain the needed cash? a. P750,000 , PB40,000 b. P788,307 J, 852,273, 38) Production Inc. has arintat sales of P30 million and accounts receivables of PLS million. They have an Inventory turnover of 4. How long Is 3 80's operating cycle? (Assume a 360-day year) a. 18 days ‘c. 108 days b. 90 days. . 72 days, Marshall Manufacturing has an average collection period (ACP) of 60 days, an inventory turnover of 6, and turns its payables over once & month. How long is Mershati's cash conversion cycle? (Assume a 360-day year) a. 30 days c. 80 days, b. 60 days 3, 120 days Coveratt Carpets Inc. is planning to borrow 12,000 from the bank. The bank offers the choice of a 12 percent discounted interest loan or a 10.19 percent ‘2dd-on, one-year installment loan, payable in 4 equal ‘quarterly payments. What is the effective rate of Interest on the 10.19 percent add-on loan? 2. 9.50% €, 15.22% BL 10.19% 3, 16.99% Tres Amigos deals strictly with three customers. The average amount each customer pays per month along with the collection delay associated with each payment is shown below. Given this information, what is the amount of the average daily receipts? Assume that every month has 30 ays Customer Check Amount Collection Delay a 712,000 days 8 725,000 4 days c 733,000 3 cays 2. PL,944.44 ©. P8,633.33 bb. P2,333.33 4, 9,333.33 Your tiem deals. strictly with four customers. The average amount each customer pays per mont) along with the collection delay associated with each payment is shown below. Given this information, what is the weighted average delay? Assume that every month has 30 days Customer Check Amount _Cotiection Delay. a 27,000 2 days B 30,500 4 days € 16,500 6 days D 22,000 3 days a. 1.89 days c. 3.55 days b. 2.13 days 6,°3.75 days Your average customer is located 5 mailing days away from your firm, You have determined that on average it {s taking your firm 2 days to process payments received from customers. In addition, it takes 3 days for your funds to be available for use once you have made your bank deposit. What is your flem’s collection time? 70 71 n 73. 74, 75, a. 4 days 2 days b. 6 days 4. 10 days For 2036, Nelson Industries increased earnings before interest and taxes by 17%. During the same period, ret income after tax increased by 42%. The dearee of financial leverage that existed during 2016 is a. 1.70 ¢. 4.20 b. 2.47 J. 5.90 A firm's current ratio is presently 1.75 to 1. ‘According to 2. working capital restriction in the firm's bond Indenture, the firm will have technically defaulted if the current ratio falls below 1.5 to 2. If the current Hiabilities are presently P250 million, the maximum new commercial paper than can be issued to finance Inventory expansion an equivalent amount without technically defaulting is 3. P 41.67 million b. 125 million . 375 million J, 962.5 milion Ren-Ren Inc.’s current capital structure is shown below. This structure is optimal, and the company wishes to maintain it Debt 25% Preferrea Equity 5 Commén Equity 70 Ren-Ren’s management is planning to build @ P75 million facility that will be financed according to this, desired capital structure, There is currently P15 million fof cash that is available for capital expansion. The percentage of the P75 million that sill come fram anew Issue of common stock is: a. 52.5% b. 56.25% . 50% d. 56% Bidder’s budgeted sales for the coming year are 60,000,000, of which 8O% are expected to be made on credit, Bidder wants to change its credit terms from 1/30 to 2/10 n/30 . If the new credit terms adopted, Bidder estimates that cash discounts would be taker on 40% of thé credit sales and the uncollectible amount would be unchanged. The adoption of the new credit terms would result in expected discounts taken in the coming year of a. P 1,200,000 fc. P.960,000 b. P "384,000 6. P 480,000 Baly Co's budgeted sales for the coming yesr are 48,000,000, of which 80% are expected to ve credit sales at terms of 0/30. BalyCo estimates that a proposed relaxation of credit terms would Increase credit sales by 30% and increase the average collection period from 30 to 45 days. Based on 3 360-day year , the proposed relaxation of credit standards would result in an expected increase in the accounts receivable batance of a. P 3,440,000 c. P 1,440,000 bb: P 3,040,000 é P 960,000 The following information regarding a change in credit policy was assembled by the Wilson Company. The compariy has @ required rate of return of 10% and 2 variable cast ratio of 60%. Old Credit Policy New Credit Palicy Sales P 3,600,000 P 3,560,000 Average DSO 30 days 36 days ‘The pretex cost of carrying the additional investment in receivables, using a 360-day year would be a. #5760 © P 8,160 b. P 3,600 3. P 960