Managemen

Section: C
ID Number: 46691
Last Name: Sol
First Name: Janesene
Examination: Pre-Final Examination

Chapter Question Type Question and Answer Solution (if Applicable)

11 MULTIPLE CHOICE QUESTIONS Question 1: Net working capital is a firm's

Answer: c. current assets less current liabilities.

Question 2: Working capital is important for all of the following reas ons except that is

Answer: c. consumes a small portion of the financial manager's time.

Question 3: The optimal level of working capital depends on all of the following factors except
Answer: b. stability of dividends.

Question 4: Which of the following assumptions does not underlie risk-return tradeoffs in managing working capita

Answer: c. The yield curve is downward sloping.

Question 5: A firm following a flexible working capital strategy would

Answer: d. minimize the amount of funds held in liquid assets.

Question 6: Restricted working capital management strategies involve

Answer: a. low-risk, low return.

Question 7: According to the compromise approach, working capital s hould be financed with
Answer: b. short-term and long-term financing.

Question 8: The probability of technical insolvency is reduced by

Answer: d. both b and c.

Question 9: W hich of the following actions would increase ris k?

Answer: c. Increase the amount of short-term borrowing.

Question 10: The matching principle s ays to

Answer: d. Match cash inflows with cash outflows.

Question 11: For a retailer with a highly seas onal s ales volume, the level of investment in __________ does not
change with changes in seas onal demand

Answer: C. Permanent current assets

Question 12: For a retailer with a highly seas onal s ales volume, the level investment in _____ does not change with
changes in s easonal demand
Answer: B. Fixed assets

Question 13: The information shown below reflects the Jed Company's current financial position:
Fixed ass ets- P1,500,000
Long-term debt-P1,000,000
Equity-P1,200,000
Sales -P1,500,000
Earnings after taxes-P202,500
Current asset turnover- 1.25
Suppose that Jed's financial manager decides t o adopt a more aggressive workng-capital policy by liquidating some
current assets and us ing the proceeds to pay off some long-term debt. Ass ume that the current ass ets are perfect
liquid. If the target current ratio is 1.5, the amount of current as sets that mus t be liquidated is

Answer: d. 450000
 Question 14: A company with a f lexible working capital policy would tend to have a _________ current asset turnove
and a ___________ current ratio than a s imilar company with a more restricted working capital policy

Answer: B. higher, lower

Problem 1:
PROBLEMS Rocco Corporation has a book net worth of P10,380. Long-term debt is P7,500. Net working capital, other than cash
P2,105. Fixed assets are P15,190. How much cash does the company have? If current liabilities are P1,450, what are
current assets ?
Answer: Cash - P585; Current Assets - P4,140 Net worth 10,380.00
Long term debt 7,500.00
Current liabilities 1,450.00
Total as sets 19,330.00
less : Fixed assets 15,190.00
Current assets 4,140.00

Current assets 4,140.00

less : Net working capital 2,105.00
Current libilities 1,450.00
Cash 585.00

Problem 2:
Indicate the effect that the following will have on the operating cycle. Us e letter (I) to indicate an increase, the letter
for a decrease and letter (N) for no change:

EFFECT
a. Average receivable goes up I
b. Credit repayment times for cus tomers are increased I
c. Inventory turnover goes from 3 times to 6 times D
d. Payables turnover goes from 6 times to 11 t imes N
e.Receivables turnover goes from 7 times to 9 times D
f. Payment to suppliers are accelerated N

Problem 3:
Indicate the impact of the following on the cash and operating cycles, respectively. Use letter (I) to indicate an incre
the letter (D) for a decrease and letter (N) for no change:

IMPACT
a. The terms of cas h dis counts offered to cus tomers arer made less favorable I, I
b. Fewer raw materials than usual are purchased D, D
c. An increased number of customers begin to pay in cash ins tead of with credit D, D
d. The cash discounts off ered by suppliers arre decreased; thus , payment are made earlier I, N
e. A greater percentage of raw material purchases are paid for with credit D, N
f. More finis hed goods are produced for inventory instead of for order I, I

Problem 4:
Consider the following financial statement information for Avocado Company

ITEM BEGINNING ENDING

Inventory P1,273 P1,401
Accounts receivable 3,872 3,368
Accounts payable 1,795 2,025
Net sales P14,750
Cos t of goods s old 11,375

Calculate the operating and cash cycles .

Answer: Operating Cycle - 132.48 days; Cash Cycle - 71.19 days OPERATING CYCLE
Inventory period:
Days per year 365
divide: Inventory turnover
COGS 11,375.00
divide: Average Inventory
[(1,273+1,401)/2] 1,337.00
Inventory turnover 8.50785
Inventory period 42.90
Receivables period:
Days per year 365
Divide: Receivables turnover
Credit sales 14,750.00
divide: Average receivables
 [(3,872+3,368)/2] 3,620.00
Receivables turnover 4.07459
Receivables period 90
Operating Cycle 132.48

CASH CYCLE
Operating cycle 132.48
less : Payables period
Days per year 365
divide: Payables turnover
COGS 11,375.00
divide: Average payables
[(1,795+2,025)/2] 1,910.00
Payables Turnover 5.95550
Payables period 61
Cash Cycle 71.19

Problem 5: Five Star Manufacturing Company

Required:
a. Determine the level of working capital, net working capital and current ratio.
Net Working Capital - P200,000; Current Ratio - 2 times NET WORKING CAPITAL
Total current assets 400,000.00
less : Total current liabilities 200,000.00
Net working capital 200,000.00

CURRENT RATIO
Total current assets 400,000.00
divide: Total current liabilities 200,000.00
Current ratio 2.00

b. Calculate the Return on equity (net income/stockholder's equity).

0.12540 or 12.54% Net income
EBIT (800,000*20%) 160,000.00
less : Interest
Current liabilities (200,000*10%) 20,000.00
Long-term liabilities (300,000*15%) 45,000.00 65,000.00
Income before taxes 95,000.00
less : Income taxes (95,000*34%) 32,300.00
Net income 62,700.00
divide: Stockholders' equity 500,000.00
Return on equity 0.12540

c. Calculate the Five Star's net woring capital and current ratio under each of the three strategies. 30% 50% 70%
30% strategy: Net working capital - P120,000; Current Ratio - 1.67 times. Current assets 300,000 500,000 700,000.0
50% strategy: Net working capital - P280,000; Current Ratio - 2.27 times. Fixed ass ets 600,000 600,000 600,000.0
70% strategy: Net working capital - P440,000; Current Ratio - 2.69 times. Total as sets 900,000 1,100,000 1,300,000.0

AT 30% STRATEGY
NET WORKING CAPITAL
Current assets (1M*30%) 300,000.00
less : Current liabilities (900K*50%*40%) 180,000.00
Net working capital 120,000.00

CURRENT RATIO
Current assets 300,000.00
divide: Current liabilities 180,000.00
Current ratio 1.67

AT 50% STRATEGY
NET WORKING CAPITAL
Current assets (1M*50%) 500,000.00
less : Current liabilities (1.1M*50%*40%) 220,000.00
Net working capital 280,000.00

CURRENT RATIO
Current assets 500,000.00
divide: Current liabilities 220,000.00
Current ratio 2.27
 AT 70% STRATEGY
NET WORKING CAPITAL
Current assets (1M*70%) 700,000.00
less : Current liabilities (1.3M*50%*40%) 260,000.00
Net working capital 440,000.00

CURRENT RATIO
Current assets 700,000.00
divide: Current liabilities 260,000.00
Current ratio 2.69

d. Explain what effect thes e strategies would have on Five Star's liquidity.

e. What is Five Star's rate of return on equity for each of the three strategies?
At 30% strategy: ROE - 0.17820 or 17.82% 30% 50% 70%
At 50% strategy: ROE - 0.13020 or 13.02% Net sales 1,000,000.00 1,000,000.00 1,000,000.00
At 70% strategy: ROE - 0.09697 or 9.70%
EBIT (18%) 180,000.00 180,000.00 180,000.00
less : Interest
Current liabilities (10%) 18,000.00 22,000.00 26,000.00
Long-term liabilities (15%) 40,500.00 49,500.00 58,500.00
Income before taxes 121,500.00 108,500.00 95,500.00
less : Income taxes (34%) 41,310.00 36,890.00 32,470.00
Net income 80,190.00 71,610.00 63,030.00

AT 30% STRATEGY
Net income 80,190.00
divide: Shareholders' equity (900K*50%) 450,000.00
ROE 0.17820

AT 50% STRATEGY
Net income 71,610.00
divide: Shareholders' equity (1.1M*50%) 550,000.00
ROE 0.13020

AT 70% STRATEGY
Net income 63,030.00
divide: Shareholders' equity (1.3M*50%) 650,000.00
ROE 0.09697

f. Describe the relations hip between Five Star's liquidity and profitability.

g. Show the expected return on equity, net working capital and current ratio for each propos ed strategy.
Restricted Strategy: Restricted e Flexible
ROE - 0.17233 or 17.23% EBIT 180,000 180,000 180,000.00
Net working capital - P200,000 less : Interest
Current ratio - 3 times Current liabilities (10%) 10,000 30,000 45,000.00
Long-term liabilities (15%) 52,500 22,500 -
Compromise Strategy: Income before taxes 117,500 127,500 135,000.00
ROE - 0.1870 or 18.70% less : Income taxes (34%) 39,950 43,350 45,900.00
Net working capital - P0 Net income 77,550 84,150 89,100.00
Current ratio - 1 time

Flexible Strategy: RESTRICTED STRATEGY

ROE - 0.1980 or 19.80% RETURN ON EQUITY
Net working capital - (P150,000) Net income 77,550.00
Current ratio - 0.6667 or 0.67% divide: Shareholders' equity 450,000.00
ROE 0.17233

NET WORKING CAPITAL

Current assets 300,000.00
less : Current liabilities 100,000.00
Net working capital 200,000.00

CURRENT RATIO
Current assets 300,000.00
 divide: Current liabilities 100,000.00
Current ratio 3.00

COMPROMISE STRATEGY
RETURN ON EQUITY
Net income 84,150.00
divide: Shareholders' equity 450,000.00
ROE 0.18700

NET WORKING CAPITAL

Current assets 300,000.00
less : Current liabilities 300,000.00
Net working capital 0.00

CURRENT RATIO
Current assets 300,000.00
divide: Current liabilities 300,000.00
Current ratio 1.00

FLEXIBLE STRATEGY
RETURN ON EQUITY
Net income 89,100.00
divide: Shareholders' equity 450,000.00
ROE 0.1980

NET WORKING CAPITAL

Current assets 300,000.00
less : Current liabilities 450,000.00
Net working capital (150,000.00)

CURRENT RATIO
Current assets 300,000.00
divide: Current liabilities 450,000.00
Current ratio 0.66670

12 MULTIPLE CHOICE QUESTIONS Question 1: During the year, Matrix Company's current assets increas ed by P120, current liabilities decreased by P5 120 + 50 = 170
Answer: d. Increased by P170.

Question 2: MBC Corporation had income before taxes of P60,000 for the year. Included in this amount was Estimated cash flow = Income before taxes + Depreciation expense + Amortization
depreciation of P5,000, a charge of P6,000 for the amortization of bond discounts, and P4,000 for interest expense
estimated cash flow for the period is

Answer: d. P71000 60000 + 5000 + 6000 = 71000

Question 3: The most direct way to prepare a cash budget for a manufacturing firm is to include
Answer: d. Projected purchases, percentages of purchases paid, and net income.

Question 4: Kassandra Corporation had income before taxes of P60,000 for the year. Included in this amount was 60000 + 5000 + 6000 = 71000
depreciation of P5,000, a charge of P6,000 for the amortization of bond discounts, and P4,000 for interest expense
estimated cash flow for the period is
Answer: d. P71000

Question 5: Shown below is a forecas t of sales for Cooper Inc., for the first 4 months of the year (all amounts are in
thousands of pesos ).
January February March April March credit sales = 90000 x 50% = 45000
Cash sales P15 P24 P18 P14 February credit sales = 120000x 30% = 36000
Sales on credit 100 120 90 70 January credit s ales =100000x 20 % = 20000
On average, 50% of credit sales are paid for in the month of s ale, 30% in the month following the sale, and the = 45000 + 36000 + 20000 + 18000 (March cash s ales) = P119000
remainder is paid 2 months after the month of sale. Ass uming there are no bad debts , the expected cash inflow for
Cooper in March is
Answer: c. P 119000

Question 6: A firm has daily cas h receipts of P100,000 and collection time for 2 days. A bank has offered to reduce Net reduction of cash reciept float = 100000 x 2 x 6% = 12000 Annual s ervice fee = 500 x 12 month
collection t ime on the firm's deposits by 2 days for a monthly fee of P500. If money market rates are expected to 6000 = 12000 - 6000 = 6000
average 6% during the year, the net annual benefit (los s) from having this service is

Answer: d. P 6000
Question 7: The treasury analyst for Gwen Corporation has es timated the cash flows for the first half of next year
(ignoring any short-term borrowings ) as follows :
Cash (P millions )
Inflows Outflows
January P2 P1
February 2 4
March 2 5
April 2 3
May 4 2
June 5 3
Gwen has a line of credit of up to P4 million on which it pas y interest monthly at a rate of 1% of the amount utilized.
Gwen is expected to have a cash balance of P2 million on January 1 and no amount utilized on its line of credit.
Assuming all cash f lows occur at the end of the month, approximately how much will Gwen pay in interest during the
first half of the year?
Answer: b. P 61000

Question 8: Helpful Services is a newly established janitorial f irm, and the owner is deciding what type of checing
account to open. Helpful is planning to keep a P500 minimum balance in the account for emergencies and plans to
write roughly 8 checkks per month. The bank charges P10 per month plus a P0.10 per check charge for a s tandard
busines s checking account with no minimum balance. Helpful also has the option of a premium business checking
account that requires a P2,500 minimum balance but has no monthly fees or per check charges. If Helpful's cost of
funds is 10%, which account s hould Helpful choose?

Answer: d. Premium account, because the savings is P 16 per year.

Question 9: If the average age of inventory is 60 days, the average age of the accounts payable is 30 days, and the

Answer: c. 75 days

Question 10: Blue Magic Toys is a retailer operating in several cities .The individual s tore managers depos it daily 2 days x .02% = .04% x P25 = P62500 (should be the ans wer)
Answer: P62,500

Question 11: A working capital technique that increases the payable float and therefore delays the outflow of cash is
Answer: b. A draft

Question 12: Assume that each day a company writes and receives checks totaling P10,000. If it takes 5 days for t If checks written require 1 more day to clear than checks is received, the net float equals 1 day's receipts. The
Answer: a. P10,000

Question 13: A compensating balance

Answer: a. Compensates a financial institution for services rendered by providing it with deposits of funds

Question 14: Four Season Company's bank requires a compens ating balance of 20% on a P100,000 loan. If the stat Interest paid (100,000 x 7%) 7,000
Answer: d. 8.75% Divided by: Available funds (100,000 x 80%) 80,000
8.75%

Question 15: A company uses the following formula in determining its optimal level of cas h.
C* = √2FT / i
Where:
F = fixed cost per transaction
i = interest rate on marketable securities
T= total demand ocas h over a period a period of time

This formula is a modification of the economic order quantity (E0Q) formula us ed for inventory management. Ass um Optimal cas h balance = Square root of (2 x 12,000 x 12 months x 10 / 6%) = 6,928
that the fixed cost of s elling marketable s ecurities is P10 per transaction and t he interest rate on marketable s ecuri Average cash balance = Optimal cash balance / 2 = 6,928 / 2
is 6% per year. The company estimates that it will make cas h payments of P12,000 over a one-month period. W hat i
the average cas h balance?

Answer: c. P3,464 Average cash balance = 3,464

Question 16: Which one of the following is not a characteristic of a negotiable certificate of deposit? Negotiable
certificates of deposits

Answer: d. have yields considerably greater than banker's acceptance and commercial paper.
 Question 17: When managing cash and short-term investments, a corporate treasurer is primarily concerned with

Answer: d. liquidity and safety.

Question 18: All of the following are alternative marketable s ecurities suitable for investment except
Answer: d. Convertible bonds.

Question 19: The term "short-selling" is the

Answer: b. selling of a security that is not owned by the seller.

PROBLEMS Problem 1: Watermelon Company

Required:
a. Fill in the table below and indicate the amount of float
Bank's Books
Initial amount ₱ 10,000
Add: Deposit 70,000
Less: Checks -25,000
Balance ₱ 55,000
Float (P 55,000- 40,000) ₱ 15,0000

Problem 2: Oscar's
Required:
a. What is the t otal value of the five checks outstanding? ₱2,480 ₱2,480
₱620 + ₱400 + ₱320 + ₱700 + ₱440

b. What is the expected value of payments for the five checks outstanding? ₱ 1, 349
Amount x Probability check has cleared
₱620 x 75% 465
₱400 x 75% 300
₱320 x 40% 128
₱700 x 40% 280
₱440 x 40% 176
₱ 1, 349
c. W hat is the difference between parts (a) and (b)? This represents a type of float.
(a – b) = ₱2,480 - ₱1,349 ₱1,131 float

Problem 3: Beth's Sociaty Inc.

Required:
a. If the firm has P4 million per day in collections and P3 million per day in disbursements, how much money has the
cash management system freed up? ₱14 ,500,000 freed up funds
₱4,000,000 daily collections x 2.5 speed up ₱10 ,000,000 additional collections
₱3,000,000 daily disbursements x 1.5 days slow down ₱4,500,000 delayed disbursements
₱14 ,500,000 freed up funds

b. How mcuh money can the firm earn per year on short-term investments made poss ible by the freed-up cas h?
₱870,000

Freed up funds ₱14 ,500,000

x Interest rate x 6%
Interest on freed up cash ₱870,000

Problem 4: Jaypee Inc.

Required:
a. What is the optimal transfer size using the Baumol model? W hat is the average cash balance? ₱ 153, 093.11

C = √2FT/I
Where:
C = Optimal transfer size
T = Total cash required during the year
F = Fixed cost per transaction
I = Rate of interest on s ecurities
C = √ [(2) (₱30,000,000) (₱125)] / 0.08
₱306,186.22 / 2 ₱ 153, 093.11
 b. What would be the ans wer to (a) if the ROI were 12% per annum and the trans fer costs were P75? W hy do they
differ from those in (a)? ₱ 96, 824. 59

C= √ [(2) (₱30,000,000) (₱75)] / 0.12

₱ 193, 649.17 / 2 ₱ 96, 824. 59

Problem 5:
Required:
a. Prepare a cas h budget for five months from January to May 20x4.
Collection from Debtors and Commission on Credit Sales
Calculation of payment to Creditors
Cash Budget of Purple Company for the months of Jan to May 2010

Problem 6:
Suppose a firm is s eeking a seven-year, amortizing P800,000 loan with annual payments and a bank is offering you Loan = Amount payment x {[ 1- ( 1+ Annual rate) ^ 7] / Annual rate}
choice between an P850,000 loan with a P50,000 compens ating balance and an P800,000 loan without a 800,000 = A x {[ 1- ( 1+ 0.085) ^7] / 0.085}
compensating balance. If the interest rate on the P800,000 loan is 8.5 percent, how low would the interest rate on thA = 800,000 / 5.11851352058
loan with the compensating balance have to be in order for you to choose it?

₱ 156,295.38

Problem 7: Find C.
7. Apple Berry Company faces a smooth annual demand for cas h of P5 million; incurs trans action costs of P225 eveAnnual demand = ₱5000000 Opportunity cost of holding cash = 4.3%
time they sell marketable s ecurities,and can earn 4.3 percent on their marketable s ecurities. W hat will be their optimCost of borrowing = ₱225
cash replenishment level? ₱228747.86

C = √ [(2) (₱5000000) (₱225)] / .043

= ₱228747.86

Problem 8: Find C.
Grapefruit Company faces a smooth annual demand for cash of P1.5 million; incurs transaction cos ts of P75 every t Annual demand = ₱1500000 Opportunity cost of holding cash = 3.7%
they sell marketable securities ,and can earn 3.7 percent on their marketable s ecurities . W hat will be their optimal ca Cost of borrowing = ₱75
replenis hment level? ₱77,981.29

C = √ [(2) (₱1500000) (₱75)] / .037

= ₱77,981.29

Problem 9: Find Optimal cash return point

Hot Foot Enterprises would like to maintain its cash account at a minimum level of P25,000, but expect the standardTrading cost per transaction = ₱200 Standard deviation in net daily cash flow
deviation in net daily cash flows to be P2,000; the effective annual rate on marketable securities to be 6.5 percent p =₱2000 Lower control limit = ₱25000
year; and the trading cos t per sale or purchase of marketable securities t o be P200 per transaction. W hat will be theDaily interes t on marketable s ecurities = 6.5%/365 ; 0.00018
optimal cash return point? ₱39938.02
C = √ [(3) (₱200) (₱2000)^2] / 4 (0.00018) + 25000
= ₱39938.02

Problem 10: Where:

10. Hot Foot Enterprises would like to maintain its cas h account at a minimum level of P25,000, but expect the standOptimal Cash return point = ₱39938.02 Lower Control limit = ₱25000
deviation in net daily cash flows to be P2,000; the effective annual rate on marketable securities to be 6.5 percent p = 3 (₱39938.02) - 2(₱25000)
year; and the trading cos t per sale or purchase of marketable securities t o be P200 per transaction. W hat will be the
optimal upper cash limit? P150,000
= ₱119814.06 - ₱50000
= ₱69814.06

13 PROBLEMS Problem 1:
Davis company sells on terms of net 45. Its annual credit s ales are P912,500 and its account receivable average 15 Average daily sales P912,500/ 365 days = P 2,500
days overdue. Ass ume a 365-day year. What is Davis' invesment in receivables?

Average collection period 45 + 15 = 60 days

Investment in accounts receivable P2,500 x 60 = P150,000
Problem 2:
Tyron Inc., has credit sales of P600,000 and an average collection period of 25 days. The firm's variable cost ratio is
percent. The opportunity cost of funds invested in accounts receivable is 15 percent. Ass ume a 365-day year.
Required:
a. What is the accounts receivable turnover for Tyron Inc.? 15 times Receivable turnover = 365/ Average collection period 365 / 25 = 14.6 or 15 times

b. What is the average investment in accounts receivable for Tyron Inc.? P 40,000 Average investment in accounts receivable = Credit s ales / Receivable Turnover P 600,000 / 15 = P 40,000

Problem 3: Butterfly Company

Required:
a. What are the marginal pretax profits for each ris k class A B C
1. Marginal profits on additional sales
b. Which ris k class es, if any, should Butterfly accept as new credit customers? Formula: Additional sales x Contribution margin
P50,000 x (100% - 85%) #NAME?
P40,000 x 15% #NAME?
P20,000 x 15% #NAME?

2. Marginal increase in bad debts loss es

Formula: Additional sales x bad debt loss ratio 2,500 3,200 2,40

3. Marginal investment in A/R

Formula: (Additional sales / 365) x 90
A = 12,329
B = 9,863
C = 4,932
Opportunity cast of marginal investment in A/R
Formula: Marginal investment in A/R x Required pretax rate of return
12,329 x 20% 2,466.00
9,863 x 24% 2,367.00
4,932 x 30% 1,480.00

Marginal pretax profit: (Marginal profits - Marginal costs) 2,534 433 -880
Problem 4: Jazz Auto Supply
The firm's opportunity cost for investing in additional receivables is 18 percent. Should Jazz adopt this change in pol Jazz Auto Supply should not adopt the change in the discount rate because the change results in a net
-211 disadvantage of ₱211.
Marginal profits on additional s ales
Formula: Additional sales x Contribution margin
₱0 x 0.25 0

= Current sales x Current bad debt los s ratio

= New sales x New bad debt los s ratio
Reduction in bad debt loss es
Formula: Current bad debt losses – New bad debt losses
₱12,000 2 ₱10,000 2,000

= Current average daily sales x Current average collection period

= New average daily sales x New average collection period
= Current average A/R balance – New average A/R balance

₱4,384 x 0.18 789

= Current sales x Current percentage taking dis count

= New sales x New percentage taking dis count x New percentage discount

₱4,800 2 ₱1,800 3,000

= Marginal returns – Marginal costs
(₱0 + ₱2,000 + ₱789) 2 ₱3,000 -211

Problem 5:
Dairy Ice Cream sells 12000 gallons of ice cream each month from its central storage facility. Monthly carrying costs
are P0.10 per gallon and ordeing costs are P50 per order. Ignore potential stockout costs and assume a 30 day mo

a. What is the economic order quantity (EOQ) for the ice cream? 3,464 gallons a. S = 12,000; O = ₱50; C = ₱0.10 3,464 gallons

b. What is the average inventory? 1,732 gallons b. The average inventory is determined by dividing the economic order quantity, Q* by 2, as follows: 1,732 gallons
c. W hat is the total inventory cost for the month? 346 per month c. C = ₱0.10; Q* = 3,464; S = 12,000 ; O = ₱50 346 per month

d. What is the optimal length of the inventory cycle? 9 days d. Q* = 3,464; Average daily demand = 12,000/30days 9 days

e. How many orders will be placed per month? 3 orders per month e. S = 12,000; Q* = 3,464 3 orders per month

Problem 6:
Fruitcake s ells 36,000 fruit cakes annually. Annual carrying cos ts are P5 pero fruit cake and the ordering cos ts are
P100 per order. The firm has decided to maintain a s afety stock of one month's sales or 3000 fruitcakes. The delive
time per order is 5 dyas. Assume a 365-day year.

Required:
a. What is the economic order quantity (EOQ)? 1,200 fruit cakes a. S = 36,000; O = ₱100; C = ₱5 1,200 fruit cakes

b. What is the average inventory? 3,600 fruit cakes b. Q* = 1,200 ; SS = 3,000 3,600 fruit cakes

c. How many orders should be placed each year? 30 orders per year c. S = 36,000; Q* = 1,200 30 orders per year

d. What is the t otal inventory cost? ₱21,000 Total inventory costs = (Average inventory x Carrying cost) + (Orders per year x Ordering cost) ₱21,000

e. What is the reorder point? 3,493 fruit cakes e. Safety Stock = 3,000; Sales = 36,000; Time period = 365 ; n = 5 3,493 fruit cakes

Problem 7: Dama de Noche

Dama de Noche Corporation is considering a change in credit policy. The current policy is cas h only, and s ales per The cos ts per period are the s ame whether or not credit is offered; so we can ignore the production cos ts. The firm
period are 2000 units at a price of P110. If credit is offered, the new price will be P120 per unit, and the credit will be currently has sales of, and collects ₱110 x 2,000 = ₱220,000 per period. If credit is offered, sales will rise to ₱120 x
extended for one period. Unit sales are not expected to a change, and all customers are expected to take credit. D 2,000 = ₱240,000.
de Noche anticipated that 4 percent of its customers will default. If the required return is 2 percent per period, is the Defaults will be 4 percent of sales, so the cash inflow under the new policy will be .96 x ₱240,000 = ₱230,400. This
change a good idea? W hat if only half the customers take the offered credit? amounts to an extra ₱10,400 every period. At 2 percent per period, the PV is ₱10,400/.02 = ₱520,000. If the switch is
made, Dama de Noche will give up this month9s revenues of ₱220,000; so the NPV of the switch is ₱300,000. If only
half of the customers take the credit, then the NPV is half as large: ₱150,000. So, regardless of what percentage of

Problem 8: Heidi Company

Heidi Company is in the process of considering a change in its terms of sale. The current policy is cas h only, the newCash flow from old policy = Quantity sold x price per unit
policy will involve one period's credit. Sales are 40,000 units per period at a price of P510 per unit. If credit is offered =40,000 x ₱510 = ₱ 20,400,000
the new price will be P537. Unit sales are not expected to change and all customers are expected to take the credit Cash flow from new policy = (Quantity sold x new price per unit) (1- Default rate)
Heidi es timates t hat 3 percent of credit sales will be uncollectible. If the required return is 2.5 percent per period, is t= 40,000(₱537) x (1 – .03) = 20,835,000 ₱-2,976,000
chane a good idea? ₱-2,976,000 The incremental cas h flow is t he difference in the two cas h flows, s o:
Incremental cash flow = ₱20,835,600 – 20,400,000 = ₱435,600
The cas h flows from the new policy are a perpetuity The cost is the old cash flow s o the NPV of the decision to

Problem 9:
Happy Feet Company sells 3,300 pairs of running shoes per month at a cas h price of P90 per pair. The firm is
considering a new policy that involves 30 days' credit and an increase in price to P91.84 per pair on credit sales. The
cash price will remain at P90, and the new policy is not expected to affect the quantity sold. The discount period will
15 days. The required return is 1 percent per month.

Required:
a. How would the new credit terms be quoted? Credit terms: 2 /15, net 30 a.The old price as a percentage of the new price is: Credit terms: 2 /15, net 30

b. What investment in receivables is required under the new policy? ₱297,000 b. No information is given concerning the percentage of customers who will take the discount. However, the maximu ₱297,000 ( at a maximum )

c. Explain why the variable cos t of manufacturing the shoes is not relevant here. c. Since the quantity sold does not change, variable cost is the same under either plan.

d. If the default rate is anticipated to be 11 percent, should the switch be made? W hat is the break-even credit price d. No, because:.02 – .11 = –.09 or –9%
What is the break-even cash discount?
Therefore the NPV will be negative. The NPV is:
NPV = –3,300(₱90) + (3,300) (₱91.84) (.02 – .11)/(.01) = –₱3,023,592

Th b k dit i i

Problem 10:
Silicon W afers Inc., is debating whether or not to extend credit to a particular customer. Silicon's products , primarilly
used in t he manufacture of s emiconductors, currently sell for P1,140 per unit. The variable cos t is P760 per unit. The
order under consideration is for 15 units today, payment is promised in 30 days.
 Required:
a. If there is a 20 percent chance of default, should Silicon fill the order? The required return is 2 percent per month. a. The cost of the credit policy switch is the quantity sold times the variable cos t. The cash inflow is the price
This is a one-time s ale and t he customer will not buy if credit is not extended. The order should be taken since the times the quantity sold, times one minus the default rate. This is a one-time, lump sum, s o we need to dis count this
NPV is positive. value one period. Doing so, we find the NPV is:
NPV = –15(₱760) + (1 – .2) (15) (₱1,140)/1.02 = ₱2,011.76

b. What is the break-even probability in (a)? 32% b. To find the breakeven default rate, π, we just need to set the NPV equal to zero and solve for the breakeven π = .3200 or 32.00%

c. In general terms , how do you think your answer to (a) will be affected if the cus tomer will purchas e the merchandis Cash discount = (₱1,140 – 1,090) / ₱1,140 = .0439 or 4.39%
for cash if the credit is refused? The cash price is P1090 per unit.Since the discount rate is less than the default
rate, credit should not be granted. The firm would be better off taking the ₱1 ,090 up-front than taking an 80%
chance of making ₱1,140.

Problem 11:
Required:
a. Based on this information, should credit be granted? Since the default probability is greater than the cash a.The cash discount is :
discount, credit should not be granted; the NPV of doing so is negative. Cash discount = (₱75 – 71) / ₱75 = .0533 or 5.33%

Th d f lt b bilit i i th b bilit f t
b. In (a), what does the credit price per unit have to be a break even? ₱77.34 Due to the increase in both quantity sold and credit price when credit is granted, an additional incremental cos t is P’ = ₱77.34

c. In (a), suppose we can obtain a credit report for P1.50 per customer. As suming that each customer buys one unit The credit report is an additional cost, s o we have to include it in our analysis . The NPV when using the credit repor
that the credit report correctly identifies all cus tomers who will not pay, should credit be extended?The reports sho is:
not be purchased and credit should not be granted. NPV = 6,200 (32) – .90 (6,900) 33 – 6,200 (71) – 6,900 (₱1.50) +
{6,900 [0.90 (75 – 33) – 1.50] – 6,200 (71 – 32)} / (1.00753 – 1)
NPV = ₱198,400 – 204,930 – 440,200 – 10,350 + 384,457.73
NPV = –₱72,622.27

MULTIPLE CHOICE QUESTIONS Question 1: Barbie Company, a retail store, is cons iderung foregoing s ales discounts in order to delay using its cas = 2%/100% - 2% x 360/30-10 = 36.7%
Supplier credit terms are 2/10, net 30. Ass uming a 360-day year, what is the annual cos t of credit if the cas h discoun
not taken and Barbie pays net 30?
Answer: d. 36.7%

Question 2: The sales manager at Raineee Company feels confidennt that, if the credit policy at Raineee's were ]
changed, s ales would increas e and cons equently, the company would utilize excess capacity. The two credit propos
being considered are as follows:
Unit sales price P300 P300 P300
Proposal A Proposal B Daily sales average unist x90 x60 x150
Increase in sales P500000 P600000 Daily sales = 27000 = 18000 =45000
Contribution Margin 20% 20% Days outstanding x10 x30
Bad debt percentage 5% 5% = 270000 + 540000
Increase in operating profits P75000 P90000 = P 810000
Desired return on sales 15% 15%

Currently, payment terms are net 30. The proposed payment terms for Proposal A and Propos al B are net 45 and ne
90, respectively. An anylsis to comapre there two propos als for the change in credit policy would include all of the
following f actors except the
Answer: b. Current bad debt experience

Question 3: Genesis Distribution s ells to retail s tores on credit terms of 2/10, net 30. Daily sales average 150 units
price P300 each. As suming t hat all s ales are on credit and 60% of customers t ake the discount and pay in day 10 w
the rest of the customers pay on day 30, the amount of Genesis' accounts receivable is
60% 40% 100%
Answer: d. P810000 Unit sales price P300 P300 P300
Daily sales average unist x90 x60 x150
Daily sales = 27000 = 18000 =45000
Days outstanding x10 x30
= 270000 + 540000
= P 810000

Question 4: A change in credit policy has caused an increase in sales , an increase in discounts taken, a decreas e i
the amount of bad debts , and a decrease in the investment in accounts receivable. Bas ed uponthis information, the
company's
Answer: a. Average collection period has decreased.
 Increase in receivable average balance = {27,000,000 × [(34 days – 28 days) ÷ 360 days]} = 450000 x 8% = 36000

Question 5: Blue Computers believes that its collection cos ts could be reduced through modification of collection
procedures. This action is expected to res ult in a lengthening of the average collection period from 28 daysto 34 day
however, there will be no change in uncollectible accounts. The company's budgeted credit sales for the coming yea
are P27,000,000 and s hort-term interest rates are expected to average 8%. To make the changes in collection
procedures cost beneficial, the minimum s avings in collection cos ts (using a 360-day year) for the coming year would
have to be
Answer: d. P36000

Question 6: A company plans to tighten its credit policy. The new policy will decrease the average number of days in
Projected credit sales for the year under the old credit policy = 50,000,000 × 70%.= 35000000
collection f rom 75 to 50 days and will reduce the ratio of credit s ales to total revenue from 70% to 60%. The companLevel of average receivable = Net credit sales ÷ Receivables turnover = 35,000,000 ÷ 4.8 times (360/75 days)=
estimates that projected sales will be 5% less if the propos ed new credit policy is implemented. If projected sales fo
7,291,667
the coming years are P50 million, calculate the peso impact on accounts receivable of this proposed change in credi
policy. Assume a 360-day year.
Answer: c. P3,333,334 decrease Under new policy: Total sales = 50,000,000 × 95% = 47.5 million, and credit sales = 47,500,000 × 60% = 28.5 million
New level of average receivable = 28,500,000 ÷ 7.2 times (360/50 days) = 3,958,333
= 7,291,667 – 3,958,333 = P3,333,334

Increase in variable costs = 720000 x 80% = $576,000 Increased

investment in receivables = 576,000 *(75 days / 360 days) = $120,000
Cost of new credit plan = 120000 x .20% = 24,000 = 720000 x 20% =
Question 7: A company with P4.8 million in credit sales per year plan to relax its credit standards , projecting that this
144000 - 24000 = 120,000
will increase credit sales by P720,000. The company's average collection period for new customers is expected to b
75 days, and the payment behavior of the existing cus tomers is not expected to change. Variable cos ts are 80% of
sales . The firm's opportunity cost is 20% before taxes. Ass uming a 360-day year, what is the company's benefit (los
on the planned change in credit terms?
Answer: d. P120000

Question 8: Which of the following represents a firm's average fross receivables balance?
I. Days' s ales in receivables x accounts receivable turnover
II. Average daily sales x average collection period
III. Net sales / average gross receivables
Answer: c. II only.

Average balance of accounts receivable = 4000 x 30 days = 120000

Question 9: A firm averages P4,000 in s ales per day and is paid, on an average, within 30 days of the sale. After the
receive their invoice, 55% of the cus tomers pay by check, while the remaining 45% pay by credit card. Approximately
how much would the company show in accounts receivable on its statement of financial position on any given date?
Answer: b. P120000

Terms of 1/10, net 60 mean t hat a buyer can save 1% of the purchase price by paying 50 days early. If we are not
taking the discount results in the buyer9s borrowing 99% of the invoice price for 50 days at a total interest charge of 1%
of the invoice price. Becaus e a year has 7.3 50-day periods (365 ÷ 50), the credit terms 1/10, net 60 yield an effectiv
annualized interest charge of approximately 7.37% [(1% ÷ 99%) × 7.3]. If the prime rate were higher than 7.37%, the
buyer would prefer to borrow from the vendor (i.e., not pay within the discount period) rather than from a bank.
Question 10: The high cost of short-term financing has recently caused a company to reevaluate the terms of credit Consequently, an 8% prime rate could cause the vendor9s receivables to increase.
extends to its cus tomers. The current policy is 1/10, net 60. If customers can borrow at the prime rate must the
company change its terms of credit in order to avoid an undesirable extension in its collection of recievables?
Answer: d. 8%

Question 11: Which one of the following would not be considered a carrying cos t associated with inventory?
Answer: d. Shipping cost

Question 12: An example of a carrying cos t is

Answer: d. Spoilage

Question 13: The result of the economic order quantity formula indicates the
Answer:d. Quantity of each individual order during the year.

14 PROBLEMS Problem 1: Camatchile Sales Company Interest Expense: .10 x P200,000,000 x 180/360 = P10million
What is the eff ective cost of credit? 46% The effective cost of credit can now be calculated as follows : 10000000 + 125,000 * 180/360
200 million - 125,0000-10 million*

5062500
94937500
equals 54% - 100%
effective cost of credit 46%
Problem 2: Jan Mfg Co.
Required:
Analyze the cost of each of the alternative sources of credit and s elect the best one. Note that a total of P500,000
be needed for a two-month period (July-August) each year.

a. 18.026% Interest for two months .14x - x500000

Loan proceeds 500000- (.2 x 500,000 + 11667)
11667 * 12
388333 * 2
rate .18026 or 18.026%
b. 24.74%
(.03/.97) x (360/15) 24.74%

c. 16.5%
Interest for two months .12 x 2/12 x P500000 = P10,000
Pledging fee .005 x P750,000 = P3,750
Rate x6= .165 or 16.5%
16.50%
Problem 3: Jelo Mfg. Company
Required:
Analyze the cost of each of thes e alternative. You may ass ume that the firm would not normally maintain any bank
balance that might be us ed to meet the 20 percent compens ating balance requirements of alternatives (b) and (c).

a. 18% Computation (.18 x P200,000)/ P200000 x1/1

Rate .18 or 18%
b. 20% Computation (.16 x P200,000) / (P200,000 - .20 x
Rate .20 or 20%
c. 21.21% Computation (.14 x P200,000) / (P200,000 -.14 x
Rate .21212 or 21.21%

Problem 4: Kiwi Company

Do you agree with Mr. Suela's proposal? Cost of not taking a cash discount .2/.98 x 360/(55-10) = 2.04% x 8
16.32%
The effective cost of the loan , 17.5%, is more than the cost of passing up the discount, 16.32%. Kiwi Corporatio Effective rate of interest with a 20% compensating balance requirement: Interest rate / (1-C)
14% / (1-.2)
14%/ .8
17.50%

Problem 5:
Ready Flashloghts , Inc. needs P300,000 to take a cash discount of 2/10, net 70. A banker will loan the money for 60
days at an interes t cost of P5500.

Required:
a. What is the effective rate on the bank loan? 10.98% Effective rate of interes t P5,500 / P300,000 x 360/60
10.98%

b. How much would it cost (in percentage terms) if the firm did not take the cas h discount, but paid the bill in 70 days Cost of los t dis count 2%/ 98% x 360/ (70-10)
instead of 10 days? 12.24%
12.24%

c. Should the form borrow the money to take the dis count?
Yes, because the cost of borrowing is less than the cost of losing the discount.

d. If the banker requires a 20 percent compensating balance, how much mus t the firm borrow to end up with the Computation P300,000/(1-C) = P300,000/ (1-.20)
P300,000? P375,0000
Amount needed to be borrowed P375,000

e. What would be the effective interest rate in part d were P6850? Should t he firm borrow with the 20 percent Computation P6,850/ (P375,000 -P75,000) x 360/60
compensating balance? (The firm has no funds to count agains t the compens ating balance requirements ) 13.68%

No, do not borrow with a compensating balance of 2% since the effective interest rate is greater than the savin Effective Interest rate 13.60%
from taking the cash discount

Problem 6: Epoch Record Company

Required:
a. Which loan should Epoch accept? Trust Bank (2x4xP9,000) / [(P100,000 -P20,000 -
Choose Northeast Bank since it has the lowest effective interest rate Effective Interest Rate 20.28%
Northeast Bank (2x12xP9,000 / [(P100,000 - P10,000) x
Effective Interest Rate 18.46%

b. Recompute the eff ective cost of interest, ass uming that Epoch ordinarily maintains at each bank P20000 in depos
that will s erve as compensating balances .
Trust Bank P72,000/ (P100,000 -P9,000) x 5
Effective Interest Rate 15.82%
Northeast Bank P216,000 / (P100,000 x 13)
Effective Interest Rate 16.62%

c. Does your choice of banks change if the assumption in part b is correct?

Yes. If the compensating balances are maintained at both banks in the normal course of business, then Trust
Bank sould be chosen over Northeast Bank. The effective cost of its loan will be less.

Problem 7:
ATPB., Inc. borrowed P1.5 million from First City Bank. The loan was made at a s imple annual rate of 9 percent a ye
for 3 months. A 20 percent compens ating balannve requirement raised the effective interest rate.

Required:
a. The nominal interest rate on the loan was 11.25 percent. W hat is the true effective rate? 11.73%

b. What would be the effective cost of the loan if the note required discount interes t? 12.09%

c. W hat would be the nominal annual interest rate on the loan if First City Bank required ATBP., Inc. to repay the loa
and interest in 3 equal monthly installments? 18%

Problem 8: Familia Inc.

Required:
a. Calculate the effective cost on pretax basis of is suing the commercial paper and, bas ed solely upon your cost Cost of commercial paper Costs incurred by using commercial
calculations, recommend the method of financing Familia Inc. should s elect. paper / Net funds available from
commercial paper
Familia Inc. should choose commercial paper because because the cost of bank financing (10.4%) exceeds the
cost of commercial paper (8.95%) by greater than 1%

1st quarter
Cost of issuing commercial paper:
Interest ( P4,000,000 x 0.0775 x 1/4) P77,500
Placement fee ( P4,000,000 x 0.00125) 5,000
First quarter cost P82,500

Funds available for use:

Funds raised P4,000,000
Less: Compensating balance P400,000
Less: Interest and placement 82,500 482,500
Net funds available in first quarter P3,517,500

Cost of commercial paper P82500 / P3517500 = 2.345%

Cost of is suing commercial paper per quarter:

Interest (P4,000,000 x 0.0775 x 1/4) P77,500

Funds available for use:

Funds raised P4,000,000
Less: Compensating balance P400,000
77,500 477,500
Net funds available per quarter P3,522,500

Cost of commercial paper P77,500 / P3,522,500 = 2.20%

Total annual effective cost of commercial paper .2345 + 3 (.022000)

Effective cost 8.95%

b. Identify the characteris tics Familia Inc. s hould pos sess in order to deal regularly in the commercial paper market.
1. Have a prestigious reputation, be financially strong, and have a high credit rating.
2. Have flexibility to arrange for large amounts of funds through regular banking channels.
3. Have a large and frequently recurring short term or seasonal needs for funds
4. Have the ability to deal in large denominations of funds for periods of one to nine months and be willing to
accept the fact that commercial paper be paid prior maturity.

Problem 9: The Canada Company

Required:
a. Calculate the expected monthly cos t of the bank financing proposal. P20,575 credit department cost. The calculations are as follows :
Interest .15 / 12 x P180,000 P2,250
Process ing .02 x P180,000 / .75 4,800
Credit department 2,500
Bad debt expense .0175 x .7 x P900,000 11,025
Expected monthly cost of bank financing P20575

b. Calculate the expected monthly cos t of factoring. P18,450 follows:

Interest .015 x P180,000 P 2,700
Factor .025 x .7 x P900,000 15,750
Expected monthly cost of factoring P18,450

c. Dis cuss three advantages of factoring.

1. Using a factor eliminates the need to carry a credit department.
2. Factoring is a flexible source of financing because as sales increase, the amount of readily available financing
increases.
3. Factors specialize in evaluating and diversifying credit risks.

d. Discuss three disadvantages of factoring.

1. The administrative costs may be excessive when invoices are numerous and relatively small in peso amount.

2. Factoring removes one of the most liquid of the firm’s assets and weakens the position of creditors. It may mar
their credit rating and increase the cost of other borrowing arrangements.
3. Customers could react unfavorably to a firm’s factoring their accounts receivable

e. Would you recommend that the firm discontinue or reduce its factoring arrangement in favor of Prime Bank's
financing plan? Explain your answer.
Based upon the calculations in Parts a and b, the factoring arrangement should be continued. The
disadvantages of factoring are relatively unimportant in this case, especially since Canada Company has been
using the factor in the past. Before arriving at a final decision, the other services offered by the factor and ban
would have to be evaluated, as well as the margin of error inherent in the estimation of the source data used in
the calculations for Parts a and b. The additional borrowing capacity needed by Canada Company is irrelevant
because the firm only needs P180,000 and the bank will loan P472,500 (P900,000 x .70 x .75) and the factor will
lend P567,000 (P900,000 x .70 x .90).

Problem 10: Billy Madison Corporation

Required:
a. Determine the average effective annual interest rate as sociated with Billy Madis on Corporation's policy of forego
all cash discounts and paying all invoices on the last day of the creasit period. Use a 360-day year in your calculatio
18.8%
The annual percentage cost of each company9s credit terms is calculated as follows:
Cost Discount / 1.00 - Dis count x 360 days/ (

The cos t of each s upplier mus t be weighted by the proportion of the total provided by the supplier.
Supplier Annual Percentage Cos t W eight Weighted
Fort Co. 0.367 0.30 0.110
Jester Co. 0.242 0.25 0.061
Jam Co. 0 0.35 0.000
Smitt & Co. 0.172 0.10 0.017
Total 1 0.188
Average effective annual interest rate is 18.8 percent

b. Would management use the information derived in Requirement a to determine when it s hould borrow funds to ta
advantage of supplier's cash discounts? Explain your answer.

No, the average effective annual interest rate does not indicate whether they should borrow funds to take
advantage of the terms on a specific account. The borrowing decision should be based on the effective annual
interest rate of each supplier’s credit terms. Money should be borrowed to pay within the discount period only
when the cost of borrowing is less than the effective annual interest rate of the credit terms. For instance, Fort
Co. has an effective annual interest rate of 36.7% and should be paid on day 10 only if the cost of borrowing is
less than 36.7%.
 c. Billy Madis on's treas urer has sugges ted that arrangements be made for a time of credit if purchas es are to be
financed.
1. W hat is a line of credit?

A line of credit is a loan agreement in which the borrower has, with certain specified limitations, control over the
amount borrowed (up to some maximum) and when the funds are repaid.
2. Is a line of credit appropriate in this s ituation? Explain your answer.
Yes, a line of credit would be appropriate for Billy Madison if the company needs to borrow short-term money to
take advantage of the cash discounts.

MULTIPLE CHOICE QUESTIONS Question 1: Accruals are "free" in the sens e that no interest must be paid on thes e funds.
Answer: A. True

Question 2: The effect of compens ating balances is to decrease commercial paper is correct?
Answer: B. False

Question 3: Which of the following statements concerning commercial paper is correct?

Answer: D. None of the above statements is correct

purchase total P1080000 per year. How much "non-free" trade credit does the firm use on average each year? P1,080,000 / 360 = P3,000 in purchas es per day. Typically, there will be P3,000 (40) = P120,000 of accounts payable
Answer: B. P90,000 on the books at any given time. Of this, P3,000 (10) is <free= credit, while P3,000 (30)
P90,000 is <non-free= credit.

Question 5: Refer to the item no. 4, What is approximate cost of the "non-free" trade credit? Approx. Cost DIscount% / (100-Discount%) x 360/
Answer: D. 24.5% 2% / (100%-2%) x 360/ (40-10)
Approx. Cost 24.50%

company's oil pipelines . Management estimated thet P2400000 will be required to put this new pump into operation.
Answer: C. Bank loan, since the cost is about 1.13 percentage points less than trade credit Effective rate on the dis count loan Interest / Face value - Interest
(P2,400,000 x .10) / [P2,400,000 - (
Effective rate on the discount loan 0.1111 or 11.11%

Credit terms are 2/10, net 40, but delaying payments 30 additional days is the equivalent of 2/10, net 70. Assumin

Approx. Cost (Days credit is outstanding - Discount

2% / (100%-2%) x 360/ (70-10)
Approx. Cost 12.24%

Therefore, the loan cost is 1.13 percentage points less than trade credit.

You plan to borrow P10000 from your bank, which offers t o lend you the money at a 10 percent nominal, or s tated, ra
Question 7: What is t he effective interest rate if the loan is a dis count loan?
Answer: A. 11.1% Effective rate on the dis count loan Interest / Face value - Interest
(P10,000 x .10) / [P10,000- (P10,000)
Effective rate on the discount loan 11.10%

payments ? Computation P1,000 / P5,000

Answer: D. 20.0% Approximate effective rate 20.00%

Computation 10% / (1-0.15-.10)

Question 9: What is t he effective interest rate if the loan is a dis count laon with a 15 percent compens ating balance?
Answer: B. 13.3% Effective rate 13.30%

P10000 / (1-.15-.10) P13,333

Question 10: Under the terms of ques tion no. 9, how much would you have to borrow to have the use of P10000?
Answer: D. P13,333 the immediate interest payment.

Question 11: If a firm had been extending trade credit on a 2/10, net 30 basis, what change would be expected on th
statement of financial position of its cus tomers if the firm went to a net cas h 30 policy?
Answer: A. increased payables

Question 12: Given that each of the following short-term sources is available, which s ource of financing is likely to ha
the highes t cost for small bus ines s?
Answer: A. trade credit
Question 13: The net effect of a compensating balance requirement on a load from the viewpoint of the borrower is
Answer: B. the effective borrowing costs will be higher than if the compensating balance were not required.

Question 14: Experience with compens ating balances in corporate bank accounts reveals that
Answer: C. banks tend to be flexible in administering compensating balances be maintained

Question 15: The financing of the basic level of current ass ets by iss uing commercial paper is inconsistent with
Answer: B. the objective of matching the maturities of assets and liabilities.

Question 16: Commercial paper tends to be quite popular with large, profitable corporations becaus e
Answer: B. interest cost are lower than the interest on ordinary bank loans and compensating balances are not
required of borrowers.

Question 17: Factoring is a credit arrangement

Answer: A. which ivolves the outright sale of accounts receivable to a factor

Question 18: A firm which finances through a factor

Answer: C. sells approved accounts receivable without recourse.

Question 19: The principal difference between factoring and pledging receivable rests in the fact that in factoring
Answer: D. the accounts receivable are ssold outright to a financial institution

Question 20: From the viewpoint of a borrower, a field warehous e arrangement is frequently considered superior to
terminal (public) warehouse arrangement becaus e
Answer: D. pledged inventory is not removed from the borrower's property to another specified location.

Interest/ proceeds = [120,000 - (0.06 x

Question 21: Ken Company obtained a short-term bank loan for P1000000 at an annual interest rate 12%. As a
100,000)]/ (1,000,000-100,000)
condition of the loan Ken is required to maintain a compens ating balance of P200000 in its checking account. The
checking account earns interest at an annual rate of 6%. Ken would otherwise maintain only P100000 in its checking
account for transactional purposes . Ken's effective interest costs of the loan is
Answer: D. 12.67% The effective rate is equal to net interest expense divided by proceeds received not proceeds borrowed. 12.67%

Question 22: A small retail business would most likely finance its merchandis e inventory with
Answer: C. a line-of-credit

Question 23: A compensating balance

Answer: D. may be required in lieu of a fee for bank services

Computation [(P1,000,000 -980,000+1200) x 4] /

(1,000,000 -20,000 -1200
Question 24: Leo Inc. can issue three-month commercial paper with a face value of P1000000 for P980000.
Transaction cos ts would be P1200. The annualized percentage cost of the f inancing would be
Answer: C. 8.67% annualized percentage cost of the financing 8.67%

Question 25: Which one of the following is a spontaneous source of financing?

Answer: D. Trade credit

Question 26: The ALT 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 (rounde Computation .07/ [1.00 (.93)-.20]
to the nearest hundredth)
Answer: D. 9.59% Effective cost of borrowing 9.58%

Question 27: The principal advantage of using commercial paper as a s hort-term financing instrument is that it
Answer: A. is generally cheaper than a commercial bank loan.

Question 28: The treasury analyst for Gundam Manufacturing has estimated t he cash flows for the firs t half of the n
year (ignoring any short -term borrowings) as f ollows:
Assuming all cash f lows occur at the end of the month, approximately how much will Gundam pay in interest during th
first half of the year?
Answer: B. P61,000 Beginning balance P2,000,000
Inflows P6,000,000
Outflows P10,000,00
Line of credit 2,000,000
rate 0.01
Interest, April 20000
Additional 1,000,000
 line of credit 2,000,000
rate 0.01
Interest, May 30,200
Interst, June (1050200 x .01) 10,502
Total interest 60,702
rounded off P61,000

Question 29: Assuming a 360-day year and that Cyber Café continues paying on the last day of the credit period, th Computation 500 =25000 x 2% , 2500 = 50000 x .05
company's weighted-average annual interes t rate for trade credit (ignoring the effects of compounding) for these tw
vendors is
Answer: B. 25.2% Cost of not taking discount [500/24500) x 360 days /(30-10)]
Weighted computation 36.73%
[(2500/47500) x 360 / (90-10)]
23.68%
company's weighted-average annual interest rate 25.20%

Question 30: Refer to data in no.29. Should Cyber Café use trade credit and continue paying at the end of the credi
period?
Answer: D. Yes, if the cost of alternative short-term fianncing is greater.

Question 31: Harry Company's bank requires a compensating balance of 20% on a P100000 loan. If the stated inter computation 7000/ (100,000 -20,000)
on the loan is 7%, what is the effective cost of the loan?
Answer:D. 8.75% effective cost of the loan 8.75%

Question 32: A company obtained a short-term bank loan of P250000 at an annual interest rate of 6%. As a conditio
of the loan, the company is required to maintain a compensating balance of P50000 in its checking account. The
company's checking account earns interest at an annual rate of 2%. Ordinarily, the company maintains a balance of
P25000 in its checking account for transaction purposes . W hat is the effective interest rate of the loan?
Answer: A. 6.44% Short term loan 250,000
Rate 0.06
Payable 15000

Available balance in checking account 25000

interest 0.02
Receivable 500

Payable 15000
receivable 500
Net payable 14500
Divide (250,000- 25,000) 225000
Effective 0.064444444
Question 33: Which one of the following provides a spontaneous source of financing for a firm?
Answer: A. Accounts Payable

Question 34: Assuming a 360-day year, the current price of a P100 B.S. Treasury bill due in 180 days on a 6% disco Computation (100x 6% x .5 year) = 3
basis is
Answer: A. P97.00 Purchase price 100-3
Purchase price 97

Question 35: Which one of the following respons es is not an advantage to a corporation that uses the commercial
paper market for short-term financing?
Answer:D.This market provides a broad distribution for borrowing.

Question 36: The cost of Alternative A is

Answer: D. 16.0%

Question 37: The cost of Alternative B is

Answer: C. 13.2%

Question 38: The cost of Alternative C is

Answer: D. 20.0%

Question 39: The cost of Alternative D is

Answer: B. 25.0%

Question 40: Commercial paper

Answer: C. Ordinarily does not have an active secondary market.
Question 41: A company enters into an agreement with a firm that will factor the company's accounts receivable. Th
factor agrees to buy the company's receivables, which average P100000 per month and have an average collection
period of 30 days. The factor will advance up to 80% of the face value of receivables at an annual rate of 10% and
charge a fee of 2% on all receivables purchased. The controller of the company estimates that the company would s
P18000 in collection expenses over the year. Fees and interest are not deducted in advance. As suming a 360-day y
what is the annual cost of financing.
Answer: D. 17.5%

Question 42: The forms of s hort term borrowing that are uns ecured credit are
Answer: D. Revolving credit, bankers' acceptances, line of credit, and commercial paper

Question 43: A firm often factors its accounts receivable. Its finance company requires a 6% reserve and charges a
1.4% commiss ion on the amount of the receivables. The remaining amount to be advanced is further reduced by an
annual interest charge of 15%. W hat proceeds (rounded to the neares t peso) will the firm receive from the finance
company at the time a P100000 account due in 60 days is factored.
Answer: C. P90,285

Question 44: Manila Company needs to pay a s upplier's invoice of P60000 and wants to take a cash discount of 2/1
net 40. The firm can borrow the money for 30 days at 11% per annum with a 9% compenating balance. Assume a 36
day year.
The amount Manila company must borrow to pay the supplier within the discount period and cover the compens ating
balance is
Answer: C. P64,615

Question 45: A company has jus t borrowed P2 million from a bank. The stated rate of interes t is 10%. If the loan is
discounted and is repayable in one year, the effective rate on the loan is approximately
Answer: D. 11.11%

Standard Bank and drew down the entire amount on February 1. The line of credit agreement requires that an amou
equal to 15%of the loan be depos ited into a compens ating balance account. W hat is the effective annual cost of cre
Answer: D. 14.12%

Question 47: Which company will give Goofy the highest proceeds from a P100000 account due in 60 days? Assume
360-day year.
Answer: A. Company E.

Question 48: Which of the following is not a negotiated source of s hort-term financing?
Answer: D. Warehouse receipt loan.

Question 49: What happens to the cost of a foregone cash discount as the number of days between the end of the
discount period and the end of the credit period increases?
Answer: D. Fluctuates erratically

Question 50: All of the following are types of trade credit except
Answer: D. Trade acceptances

Question 51: Stretching accounts payable is likely to do all of the following except
Answer: B. Lower the buyer's credit rating.

Question 52: For which type of loan is the s tated interest equal to the effective interest rate?
Answer: C. Simple Interest loan

Question 53: Small business firms are generally unable to use which of the following sources of s hort-term funds?
Answer: D. Floating lien

Question 54: Inventory used as collateral s hould generally not be highly

Answer: B. marketable

Question 55: Floor planning is a type of short-term financing using

Answer: C. Trust receipts

Question 56: Which t ype of inventory financing provides the least amount of security to the lender?
Answer: D. Blanket lien

Question 57: Which of the following is not a form of unsecured short-term financing?
Answer: B. Trade credit