02 Working Capital Management

LOA :TOPIC 02_WORKING CAPITAL MANAGEMENT AY 2021-2022
COLLEGE OF BUSINESS AND ACCOUNTANCY

FINANCIAL MANAGEMENT
TOPIC 02 – WORKING CAPITAL MANAGEMENT
TOPIC OUTLINE
Definition
Operating Cycle and Cash
Conceversion Cycle
Conservative
Basic Investment Policy
Concepts Aggressive
Working Capital Policy Conservative
Relevant Costs Financing Policy Maturity Matching
Objective
Aggressive
Cash and MS
Cash Management
Management
MS Management
WORKING CAPITAL
MANAGEMENT Objective
AR Management
Credit Policy
Objective
Inventory
Techniques
Management
Optimal Safety Stock
Accrued Expenses
Trade Credit
Current Liabilities
Short-term Loans
Commercial Paper
LECTURE NOTES
BASIC CONCEPTS
DEFINITION
Working capital management involves managing the firms current assets and liabilities to achieve a balance
between profitability and risk that contributes positively to the firms value.
Working capital management is all about RISK AND RETURN TRADE-OFF. Generally, the higher the risk, the
higher the return. Thus, the yield curve is upward sloping.
Current assets are the least profitable assets of the company. Therefore, investment in working capital
involves lower return. The lower the return, the lower the risk, right? But why lower risk? It is because
investment in working capital more has given the company a greater liquidity, thus a lower default risk.
Therefore, PROFITABILITY is INVERSELY related to LIQUIDITY.
OPERATING CYCLE AND CASH CONVERSION CYCLE
OPERATING CYCLE – the length of time in which the firm purchase inventories,
sell it and receive cash from sale.
OPERATING CYCLE = DAYS INVENTORY + DAYS AR
CASH CONVERSION CYCLE - the length of time the funds are tied up in working capital
or the length of time between paying for working capital
and collecting cash from sale of inventory.
CASH CONVERSION CYCLE = OPERATING CYCLE – DAYS AP
NOTE: Cash conversion cycle is the basis for how much the company should invest in working capital.
See sample discussion below.
Management Advisory Services by Karim G. Abitago, CPA Page 1 of 27

Aim…Believe..Claim
Sample discussion:
Assuming the days to convert inventory to AR is 65 days and the number of days to collect AR is 55 days.
Thus, the operating cycle is 120 days. The company will not be receiving cash until 120 days. The Days AP
is 67 days. The available cash of the company will be paying AP. Thus there will be 53 days without cash.
This is the time that the company must fund 53 days, the cash conversion cycle.
NOTE: The goal of the company is to shorten the cash conversion cycle by SHORTENING the OPERATING
CYCLE or LENGTHENING the DAYS AP.
WORKING CAPITAL POLICY
INVESTMENT POLICY (Where to invest?)
Conservative Aggressive
Description Relaxed Restricted
Level of current assets High Low
Liquidity High Low
Profitability and net returns Low High
FINANCING POLICY (Sources of financing)
For working capital management purposes, assets are classified as temporary and permanent. Temporary
assets or seasonal assets are current assets that vary over the year. Permanent assets are current and
fixed assets that remain unchaged over the year.
The assets mentioned above shall be financed depending on the working capital financing policy below:
(1) Conservative or relaxed policy - involves financing almost all asset investments with long-term
capital.
(2) Aggressive or restricted policy - uses short-term liabilities to finance, not only temporary, but also
part or all of the permanent current asset requirement
(3) Maturity matching or hedging policy - matching the maturity of a financing source with specific
financing needs. Temporary assets are financed by short-term financing and permanent assets are
financed by long-term financing
MATURITY
CLASSIFICATION OF ASSETS AGGRESSIVE CONSERVATIVE
MATCHING
SHORT-TERM
TEMPORARY SHORT TERM
SHORT-TERM DEBT
CURRENT ASSETS DEBT
DEBT
ASSETS
PERMANENT
ASSETS LONG-TERM
LONG-TERM DEBT DEBT
PERMANENT LONG-TERM DEBT
FIXED ASSETS
ASSETS
ADDITIONAL FUNDING NEEDED OR EXTERNAL FINANCING NEEDED

This shows that the internal financing of the company in the form of incremental retained earnings are
insufficient to fund the increase in spontaneous net assets. Spontaneous net assets are the net assets that
vary directly with sales.
SOLUTION GUIDE:
Increase in spontaneous net assets (∆ Sales x spontaneous net assets percentage) xx
Increase in retained earnings (Expected sales x profit margin x retention ratio) (xx)
External financing needed xx
COSTS RELEVANT IN INVESTMENT OF CURRENT ASSET
Carrying costs - costs associated with having current assets. (e.g.
opportunity costs and storage costs)
Shortage costs - costs associated with NOT having current assets. (e.g.
transaction costs and stock-out costs)
CASH AND MARKETABLE SECURITIES MANAGEMENT
OBJECTIVE: To invest cash for a return while retaining some for liquidity and to satisfy
future needs. NOTE: Cash is the least profitable asset.
MOTIVES OF HOLDING CASH
(a) Transaction motive - firms maintain cash balances that they can use to conduct the ordinary business
transactions; cash balances are needed to meet cash outflow requirements for operational or financial
obligations.
(b) Precautionary motive - firms hold cash balance in order to handle unexpected problems or
contingencies due to the uncertain pattern of cash inflows and outflows.
(c) Speculative motive - firms delay purchases and store up cash for use later to take advantage of
possible changes in prices of materials, equipment, and securities, as well as changes in currency
exchange rates.
(d) Contractual motive – firms hold cash to comply to a contractual condition. (e.g. compensating
balance)

THE CONCEPT OF FLOAT

FLOAT is defined as the difference between balance per book and balance per bank.
Types of float
(a) Positive float or disbursement float – bank balance > book balance
(b) Negative float or collection float – bank balance < book balance (e.g. mail float, processing float and
clearing float)
NOTE: Good cash management suggests that positive float be maximized while negative float be
minimized.
CASH MANAGEMENT STRATEGIES
(1) To accelerate collections (e.g. prompt billing and offering discounts, online banking, lockbox system)
(2) To control or slow down disbursements (e.g. stretching payables, less frequent payroll, pay through
checks and drafts, maintain zero-balanced accounts, concentration banking)
CASH FLOW MANAGEMENT
Cash flow can be managed by:
(1) Preparing cash budgets
(2) Preparing the cash break-even chart
Cash break-even chart shows
(a) THE CASH BREAK-EVAN POINT – the amounts sales in pesos or the number of units to be sold
so that the total cash inflows is equal to the cash outflows.
(b) THE AMOUNT OF CASH DEFICIENCY when sales is below the cash break-even point, or the
amount of excess cash when sales is above the cash break-even point.
(3) Determining the optimal cash balance using the Baumol Cash Management Model
BAUMOL MODEL - an EOQ-type model which can be used to determine the optimal cash balance where the
costs of maintaining and obtaining cash are at the minimum.
Such costs are the:
(a) cost of securities transactions or cost of obtaining a loan;
(b) opportunity cost of holding cash which includes the return foregone by not investing in
marketable securities or the cost of borrowing cash.
Optimal Cash Balance
Total costs of cash balance = Holding costs + Transaction costs

 HOLDING COSTS = Average cash balance x opportunity cost
 TRANSACTION COSTS = Number of transactions x cost per transaction
NOTE: Number of transactions can be computed as (Annual cash requirement ÷ OCB) and average cash
balance can be computed as (OCB ÷ 2)
MARKETABLE SECURITIES - short-term money market instruments that can easily be converted to cash
Examples:
(1) Government Securities
• Treasury bills - debt instruments representing obligations of the National Government issued by
the Central Bank and sold at a discount through competitive bidding.
• CB Bills or Central Bank Certificates of Indebtedness (CBCIs) - represent indebtedness by the
Central Bank
(2) Commercial Papers (CPs) - short-term, unsecured promissory notes issued by corporations with very
high credit standing.
(3) Certificate of deposits – savings deposits at financial institutions (e.g. time deposit)
(4) Money market funds – shares in a fund that purchases higher-yielding bank certificate of deposits,
commercial paper and other large-denomination, higher yielding securities.
NOTE: Government issued securities are considered to be the safest securities (lower return) and
commercial papers are considered to be the securities with highest return.
FACTORS TO CONSIDER IN CHOOSING MARKETABLE SECURITIES
(1) Risk
a. Default Risk - refers to the chances that the issuer may not be able to pay the interest or
principal on time or not at all.
b. Interest Rate Risk - refers to fluctuations in securities' price caused by changes in market
interest rates.
c. Inflation Risk - refers to the risk that inflation will reduce the "real value" of the investment.
(2) Marketability - refers to how quickly a security can be sold before maturity without a significant price
concession
(3) Term to Maturity - maturity dates of marketable securities held should coincide, when possible, with
the date at which the firm needs cash, or when the firm will no longer have cash to invest.

ACCOUNT RECEIVABLE MANAGEMENT

OBJECTIVE: To have both the optimal amount of receivables outstanding and the
optimal amount of bad debts. This balance requires the trade-off between
the benefit of more credit sales, and the costs of accounts receivable
such as collection, interest, and bad debts cost
CREDIT POLICY
This is a set of guidelines for extending credit to customers. The company may choose between a
conservative or aggressive policy.
POLICY SALES COLLECTION PERIOD AR BALANCE BAD DEBTS
AGGRESSIVE ↓ ↓ ↓ ↓
CONSERVATIVE ↑ ↑ ↑ ↑
TERMINOLOGIES USED
 Credit cap – also known as credit limit. It refers to the maximum or ceiling amount of credit given to
customers.
 Credit block – refers to action of credit department where a customer is not granted line of credit.
 Credit class – pertains to the group of customers.
NOTE: The treasurer is generally responsible for the credit and collection function.
COMPONENTS OF CREDIT POLICY
(1) Credit standards – the criteria that determine which customers will be granted credit and what is the
limit. The following are the factors to consider in establishing credit standards. (The 5 C’s of Credit)
(a) Character – customers’ willingness to pay
(b) Capacity – customers’ ability to generate cash flows
(c) Capital – customers’ financial sources
(d) Conditions – current economic or business conditions
(e) Collateral – customers’ assets pledged to secure debt.
(2) Credit terms – this defines the credit period and discount offered for customers’ prompt payment.
(3) Collection policy – refers to the procedures the firm follows to collect accounts including past
accounts.
FREQUENTLY ASKED QUESTIONS ON AR MANAGEMENT
(1) Days Sales Outstanding (DSO) or Average Collection Period
If the problem is silent, DSO is the credit term. Otherwise, DSO is computed as the average days of
collection by the company.
(2) Net advantage or disadvantage of change in policy
Benefit (increase in contribution margin) xx
Costs:
Incremental bad debts expense (xx)
Incremental carrying cost on accounts receivable(a) (xx)
Net benefit (loss) xx
NOTES:
(a) The incremental carrying cost on accounts receivable is computed by multiplying the incremental
investment on accounts receivable to the opportunity cost rate.
(b) The net benefit (loss) should be after-tax.
INVENTORY MANAGEMENT
OBJECTIVE: To maintain inventory at a level that best balances the estimates of actual
savings, the cost of carrying additional inventory, and the efficiency of
inventory control.
INVENTORY MANAGEMENT TECHNIQUES
(1) INVENTORY PLANNING – involves determination of the quality and quantity and location of inventory,
as well as the time of ordering, in order to meet future business requirements.
(a) ECONOMIC ORDER QUANTITY - the quantity to be ordered, which minimizes the sum of the
ordering and carrying costs. The total inventory cost function includes:
 Carrying Costs (which increase with order size)
(1) Storage costs (3) Spoilage
(2) Interest costs (4) Insurance
 Ordering Costs (which decrease with order size)
(1) Transportation (delivery costs)
(2) Administrative cost of purchasing and costs of receiving and inspecting goods
Total costs of inventories = Ordering costs + Carrying costs

 CARRYING COSTS = (Average inventory + Safety stock) x carrying cost per unit
 ORDERING COSTS = Number of times the company will order x ordering costs

NOTES:
(1) Number of times the company will order can be computed as (Annual demand in units ÷ EOQ)
and average inventory can be computed as (EOQ ÷ 2)
(2) When applied to manufacturing operations, the EOQ formula may be used to compute the
Economic Lot Size (ELS)
(b) SAFETY STOCK AND REORDER POINT
REORDER POINT is a stock-out problem, the objective is to order at a point in time so as not to run
out of stock before receiving the inventory ordered but not so early that an excessive quantity
of safety stock is maintained.
The computation of reorder point depends if lead time (period between the time the order is
placed and received) is constant or fluctuating.
If lead time is constant: REORDER POINT = AVE. USAGE x NORMAL LEAD TIME
If lead time is fluctuating: REORDER POINT = (AVE. USAGE x NORMAL LEAD TIME) +
SAFETY STOCK or AVE. USAGE X MAXIMUM LEAD TIME)
(2) INVENTORY CONTROL - regulation of inventory within predetermined level; adequate stocks should
be available to meet business requirements, but the investment in inventory should be at the
minimum.
(a) Fixed Order Quantity System - an order for a fixed quantity is placed when the inventory level
reaches the reorder point.
(b) Fixed Reorder Cycle System (periodic review or replacement system) - orders are made after a
review of inventory levels has been done at regular intervals.
(c) Optional Replacement System
(d) ABC Classification System- inventories are classified for selective control:
A items - high value items requiring highest possible control
B items - medium cost items requiring normal control
C items - low cost items requiring the simplest possible control
(e) Materials Requirement Planning (MRP) - designed to plan and control raw materials used in
production. The demand for materials, which is assumed to be dependent on some factors, is
programmed into a computer.
(f) Enterprise Resource Planning (ERP) - integrates the information systems of the whole
enterprise. All organizational operations are connected and the organization itself is connected
with its customers and suppliers.
SHORT-TERM CREDIT
FACTORS CONSIDERED IN SELECTING THE SOURCE OF SHORT-TERM FINANCING
(1) Cost - short-term debt is less expensive.
- short-term rates are usually lower than long-term rates.
- short-term debts do not normally involve flotation or placement costs.
(2) Availability of the short-term funds when needed.
(3) Risk - short-term debts are riskier. Interest rates may fluctuate and more frequent debt servicing is
required.
(4) Flexibility - short-term credit is usually more flexible than long-term debt. Short-term loans can be
arranged more quickly. Some lenders are more willing than others to work with the borrower, e.g., to
periodically adjust the amount when needed.
(5) Restrictions - certain lenders may impose restrictions, such as requiring a minimum level of net
working capital.
(6) Effect on Credit Rating - some sources of short-term credit may negatively affect the company's
credit rating.
(7) Expected Money-market Conditions
(8) Inflation
(9) The company's profitability and liquidity positions, as well as the stability of its operations.
SOURCES OF SHORT-TERM CREDIT
A) SPONTANEOUS SOURCES
(1) Accruals (Accrued Expenses) - form of spontaneous financing, which represent liabilities for
services that have been provided to the company but have not yet been paid for. Typical
examples are accrued wages and taxes. NOTE: Cost of Accruals - None, whether implicit or
explicit cost.
(2) Deferred Income - customers' advance payments or deposits for goods or services that will be
delivered at some future date. Cost of Deferred Income – None.
(3) Trade Credit - considered as a spontaneous financing because it is automatically obtained when
a firm purchases goods or services on credit from a supplier. It is a continuous source of
financing. It is more readily available than other negotiated sources of short-term credit. If a
supplier allows a trade discount for prompt payment, an implicit cost is incurred if the discount
is not availed of.

The general formula used in computing the cost of short-term financing is:
Annual Cost Interest cost per period Number of days in a year
= x
Rate Usable loan amount Number of days funds are used
For cost of trade credit, the modified formula is:
Annual Cost of Discount % Number of days in a year
= x
Trade Credit 100% - Discount % Net Period – Discount Period
B) Unsecured Short-Term Credit
(1) Commercial Bank Loans - short-term business credit provided by commercial banks, requiring
the borrower to sign a promissory note to acknowledge the amount of debt, maturity and
interest.
(2) Line of Credit - the bank agrees to lend up to a maximum amount of credit to a firm. This is
applicable to firms that need frequent funding in varying amounts.
(3) Revolving credit agreement - the bank makes a formal, contractual commitment to provide the
maximum amount to a firm. The firm pays a minimal commitment fee per year on the average
unused portion of the commitment.
(4) Transaction Loan (a single payment loan) - short-term credit for a specific purpose.
For cost of short-term bank loan, the modified formula is:
Annual Cost of Net Interest Number of months in a year
= x
Short-term Loan Usable Proceeds Term
NOTEs:
(1) Net interest is computed as:
 Interest expense paid (+)
 Transaction costs, if any (+)
 Interest income on incremental compensating balance (-)
(2) Usable proceeds is computed as:
 Principal amount (+)
 Discount, advance interest paid (-)
 Incremental compensating balance (-)
 Transactions costs (-)
(5) Commercial Paper - short-term, unsecured promissory notes (IOUs) issued by large firms with
great financial strength and high credit rating to other companies and institutional investors,
such as trust funds, banks, and insurance companies. Commercial papers entail lower cost than
bank financing (the interest rate is usually lower that the prime rate and the costly financial
arrangements are avoided). One disadvantage, however, is their limited access and availability.
Only the largest firms with the greatest financial strength can issue commercial papers. The
amount of funds available is limited to the excess liquidity of big corporations.
For cost of commercial paper, the modified formula is:
Annual Cost of Interest + Issue Costs 360 Days
= x
Commercial Paper Face Value – Interest – Issue Costs Term
C) Secured Short-Term Credit
(1) Pledging Receivables - a certain peso amount of receivables is provided by the borrowers as
collateral for a short-term loan.
(2) Pledging Inventories - part or all of the borrower's inventories are provided by the borrowers as
collateral for a short-term loan
Classifications of Inventory Loans:
(a) Floating Lien - the creditor (lender) has a general claim on all of the borrower's inventory. The
lender acquires title to the inventory and the borrower cannot control its size or disposition.
(b) Trust Receipt - the lender holds title to specific units of inventory pledged which are identified in
writing on documents called trust receipts.
(c) Warehouse Receipt - the inventory pledged is placed under the lender's physical and legal
possession. The pledged inventory is stored in a public warehouse controlled by the
warehousing company, The inventory is released to the borrower only when such release is
authorized by the lender.
(3) Other Source or Short-Term Funds
(a) Factoring of Accounts Receivables - A factor buys the accounts receivable of a firm and assumes
the risk of collection.
(b) Banker’s Acceptance - Often used by importers and exporters, these are drafts drawn by a non-
financial firm on deposits at a bank. The bank's acceptance is a guarantee of payment at
maturity.

DISCUSSION EXERCISES
STRAIGHT PROBLEMS
WORKING CAPITAL INVESTMENT AND FINANCING POLICY
1. AATROX CORP. is currently in the process of preparing its financial plan for next year 2020. The fol -
lowing estimations are related to the said financial plan: (all amounts in millions PHP)
Month CA Month CA Month CA
Jan 20.2 May 42.5 Sept 44.4
Feb 19.4 June 43.8 Oct 37.6
Mar 25.7 Jul 38.6 Nov 49.4
Apr 35.1 Aug 40.2 Dec 29.8
AATROX fixed assets is expected to be constant over the year amounting to P80 million.
REQUIREMENTS:
(a) Determine the amount of temporary and permanent amount of assets of AATROX CORP.
(b) Determine the amount of short-term and long-term amount of financing assuming
(1) Working capital policy requires that 50% of temporary assets be financed with permanent
financing.
(2) Working capital policy requires that 50% of permanent current assets be financed with
temporary financing.
2. AHRI COMPANY has P8,000,000 in current assets, P3,500,000 of which are considered permanent
current assets. In addition, the firm has P6,000,000 invested in fixed assets. AHRI wishes to finance
all fixed assets and permanent current assets plus half of its temporary current assets with long-term
financing costing 15 percent. Short-term financing currently costs 10 percent. AHRI’s earnings before
interest and taxes are P2,200,000. Income tax rate is 40 percent.
REQUIREMENT: How much would AHRI COMPANY’s earnings after taxes under this financing plan?
3. The 2019 sales of AKALI INC. amounted to P10 million. The dividend payout ratio is 20%. The per -
cent of sales in each balance sheet item that varies directly with sales are expected to be as follows:
Cash 10%
Receivables 20%
Inventories 10%
Net fixed assets 15%
Accounts payable 15%
Accrued expenses 10%
Net profit rate 9%
REQUIREMENT:
(a) Suppose that in 2020 sales increased by 20% over 2019 sales. How much additional (external)
capital will be required?
(b) Compute the projected additional financing needed for 2020 assuming Sales next year is
P15,000,000 and the payout ratio is 40%.
CASH MANAGEMENT, OPERATING CYCLE & CASH CONVERSION CYCLE
4. ALISTAR CORP., a leading producer of microchips, turns out 2,000 microchips a day at a cost of P300
per battery for prime cost. It takes the firm 30 days to convert raw materials into microchips. ALIS -
TAR allows its customers 25 days in which to pay for the batteries, and the it pays suppliers on a 20-
day basis.
REQUIREMENTS:
(a) How long is ALISTAR’s operating cycle and cash conversion cycle, respectively?
(b) At a steady state in which ALISTAR produces 2,000 batteries a day, what amount of working
capital must it finance?
(c) If ALISTAR can stretch its DAYS AP into 30 days, by what amount could ALISTAR reduce its
working capital financing needs?
5. It usually takes AMUMU INC. 15 calendar days to receive and deposit customer remittances. The sys-
tem is expected to reduce mailing time by 3 days, reduce processing time by 2.5 days, and reduce
check clearing time by 0.5 day. The average daily cash receipts are P80,000. The expected rate of re-
turn is 8%.
REQUIREMENTS:
(a) How much cash would the lock-box system free up for the company?
(b) What is the maximum amount that AMUMU would be willing to pay for the lock-box system?
(c) If the lock-box system could be arranged at an annual cost of P300,000, what would be the an-
nual net gain from instituting the system?
6. ANIVIA CORP. projects that cash outlays of P45 million will occur uniformly throughout the year.
ANIVIA plans to meet its cash requirements by periodically selling marketable securities from its port-
folio. The firm’s marketable securities are invested to earn 12 percent, and the cost per transaction of
converting securities to cash P30.
REQUIREMENTS: (a) Compute the total annual cost based on optimal transaction size. (b) Compute
the total annual cost if the transaction size is P200,000. (c) Compute the total annual cost if the
transaction size is P100,000.

ACCOUNTS RECEIVABLE MANAGEMENT

7. ANNIE CORP. sells on terms of 2/15, n/30. Total sales for the years are P864,000. 60% of the cus-
tomers pay on the 15th day and take discounts. The remainder pay, on average, 40 days after their
purchases. Assume 360 days per year.
REQUIREMENTS: (a) What is the days sales outstanding? (b) What is the average amount of receiv-
ables?
8. ASHE INC. currently has sales of P2.5 million. Its credit period and days sales outstanding (DSO) are
both 30 days, and 1 percent of its sales end up as bad debts. The credit manager estimates that, if
the firm extends its credit period to 45 days so that its days sales outstanding increases to 45 days,
sales will increase by P250,000, but its bad debt losses on the incremental sales would be 2.5 per -
cent. Variable costs are 60 percent, and the cost of carrying receivables, k, is 12.5 percent. Assume a
tax rate of 40 percent and 360 days per year.
REQUIREMENTS:
(a) Compute the incremental investment required to finance the increase in receivables if the
change is effected.
(b) What would be the incremental cost of carrying receivables?
(c) What would be the effect of those changes in net income?
INVENTORY MANAGEMENT
9. The AURELION COMPANY purchases 20,000 units of a major component part each year. The firm's or-
der costs are P200 per order and the carrying cost per unit is P2 per year.
REQUIREMENTS
(a) Compute the total inventory costs associated with placing orders of 20,000, 10,000, 5,000,
1,000.
(b) Determine the EOQ for the component parts.
10. A company annually consumes 50,000 units of Part X. The carrying cost of this part is P3.00 per year
and the ordering costs are P200. The company uses an order quantity of 5,000 units.
REQUIREMENTS:
Based on the information, compute:
(a) Average number of inventory units.
(b) Number of orders per year.
(c) Using 360 days a year, the frequency of making an order.
(d) The annual inventory costs, broken down into ordering and carrying costs.
(e) The economic order quantity. Compute the amount of annual inventory costs if the company
uses the economic order quantity.
11. The following information is available for AZIR CORP.’s Material ABC.
Annual usage 12,600 units
Working days per year 360 days
Normal lead time 20 days
The units of Material ABC are required evenly throughout the year.
REQUIREMENTS:
A. What is the reorder point?
B. Assuming that occasionally, the company experiences delay in the delivery of Material ABC,
such that the lead time reaches a maximum of 30 days, how many units of safety stock should
the company maintain and what is the reorder point?
12. Each stockout of a product sold by BARD CORP. costs P1,750 per occurrence. The carrying cost per
unit of inventory is P5 per year, and the company orders 1,500 units of product 24 times a year at a
cost of P100 per order. The probability of a stockout at various levels of safety stocks is.
Units of safety stock Probability of stockout
0 .50
100 .30
200 .14
300 .05
400 .01
REQUIREMENT: The optimal safety level for the company is
TRADE CREDIT
13. The following information is related to the trade credit for each supplier of BLITZCRANK INC.:
SUPPLIER CREDIT TERM DATE OF PAYMENT
A 3/15 net 40 On the 30th day
B 2/10 net 30 On the 35th day
C 1/5 net 20 On the 30th day
REQUIREMENTS:
(a) What is the nominal cost and effective cost of giving up the cash discount from each supplier?
(b) 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.

SHORT-TERM BANK LOAN

14. BRAND COMPANY is negotiating with BRAUM CITY BANK for a P1M, 1-year loan. BRAUM CITY BANK
has offered BRAND COMPANY the following alternatives. Calculate the effective annual interest rate
for each alternative. Redo requirement (A) to (F) assuming the loan is for four (4) months.
(A) A 12.5 percent annual rate on a simple interest loan, with no compensating balance required
and interest due at the end of the year.
(B) A 9.25 percent annual rate on a simple interest loan, with a 20 percent compensating balance
required and interest again due at the end of the year.
(C) A 8.75 percent annual rate on a discount loan, with a 20 percent compensating balance.
(D) A 8.75 percent annual rate on a discount loan, with a 20 percent compensating balance and an
existing cash balance of P150,000
(E) A 8.75 percent annual rate on a discount loan, with a 20 percent compensating balance which
earns 5% interest income.
(F) A 8.75 percent annual rate on a discount loan, with a 20 percent compensating balance and an
existing cash balance of P150,000. The bank balance earns 5% interest income.
COMMERCIAL PAPER
15. CAITLYN CORP. can issue a four-month commercial paper with a face value of P1,000,000 for
P985,000. Transaction costs would be P2,400. REQUIREMENT: What is the annualized cost of the
commercial paper?
FACTORING OF RECEIVABLES
16. CAMILLE CORP. enters into an agreement with a firm that will buy CAMILLE’s accounts receivable and
assume the risk of collection.
Details about the agreement are as follows:
Average amount of receivable to be factored each month P300,000
Average collection period 30 days
Amount to be advanced by the factor 75% of the face amount of the receivables
Interest rate, deductible in advance 12% p.a.
Factor’s fee, deductible in advance 3%
Annual savings of CAMILLE CORP in collection expenses: P40,000
REQUIREMENTS:
(a) How much is the monthly net proceeds from factoring the receivables?
(b) What is the annual net cost of factoring?
(c) What is the effective annual cost rate of financing?
(d) If the interest charge and factor’s fee is not deducted in advance, the effective annual cost rate
is
SHORT-TERM FINANCING ALTERNATIVES
17. CASSIOPEIA INC. can buy equivalent materials from two-distributors. Supplier A offers term 1/10,
net 30 whereas Supplier B provides terms of 2/15, net 60.
REQUIREMENTS
(a) If CASSIOPEIA foregoes the discount, which of the two suppliers should it purchase from if sup-
ply prices are comparable.
(b) If CASSIOPEIA can borrow from Lending Bank at a 16%, should it forego the discount?
(c) If in (b) above the bank requires a 20% compensating balance for the loan, should the firm
forego the discount?
MULTIPLE CHOICE (THEORIES)
1. As a company becomes more conservative with respect to working capital policy, it would tend to
have a(n)
A. Increase in the ratio of current liabilities to noncurrent liabilities.
B. Decrease in the operating cycle.
C. Decrease in the quick ratio.
D. Increase in the ratio of current assets to noncurrent assets.
2. A firm following an aggressive working capital strategy would (M)
A. Hold substantial amount of fixed assets.
B. Minimize the amount of short-term borrowing.
C. Finance fluctuating assets with long-term financing.
D. Minimize the amount of funds held in very liquid assets.
3. Which of the following statement is false?
A. Net working capital equals working capital less current liabilities.
B. A firm with a current ratio greater than one has positive net working capital.
C. Working capital management concerns decisions about all of a firm’s assets.
D. Net working capital is that portion of a firm’s current assets financed with long-term funds.
4. An advantage of the use of long-term debt as opposed to short-term debt to finance current assets is
A. It is easy to repay C. It generally is less costly than short-term debt
B. It decreases the risk of the firm D. It generally places fewer restrictions on the firm

5. Which of the following statements is true?

A. Short-term debt is usually more expensive than long-term debt.
B. A conservative working capital policy is characterized by higher current ratio and acid-test ratio.
C. Determining the appropriate level of working capital for a firm requires changing the firm’s
capital structure and dividend policy.
D. Liquid assets do not ordinarily earn higher returns relative to long-term assets, so holding the
former will maximize the return on total assets.
6. The length of time it takes for the initial cash outflows for goods and services to be realized as cash
inflows from sales is called
A. Cash conversion cycle C. Product life cycle
B. Manufacturing cycle D. Vicious cycle
7. As a firm's cash conversion cycle increases, the firm:
A. becomes less profitable C. reduces its accounts payable period
B. incurs more shortage costs D. increases its investment in working capital
8. An objective of cash management is to
A. Maximize the cash balance to avoid the risk of illiquidity.
B. Minimize the cash balance to maximize the return from idle cash.
C. Reserve as much cash as possible for potential investment opportunities.
D. Invest cash for a return while retaining sufficient liquidity to satisfy future needs.
9. According to John Maynard Keynes, the three major motives for holding cash are for
A. Transactional, psychological, and social purposes.
B. Speculative, fiduciary, and transactional purposes.
C. Speculative, social, and precautionary purposes.
D. Transactional, precautionary, and speculative purposes.
10. Which of the following statements concerning zero balance accounts is not correct?
A. They are set up to handle disbursement activity
B. The account has a minimum amount at all times
C. Checks are automatically transferred into the account as checks presented for payment
D. The transfer is automatic and involves an accounting entry only
E. The master and the zero balance account locate at the same bank
11. Which of the following statements is most correct? (E)
A. A cash management system that minimizes collections float and maximizes disbursement float
is better than one with higher collections float and lower disbursement float.
B. A cash management system that maximizes collections float and minimizes disbursement float
is better than one with lower collections float and higher disbursement float.
C. The use of a lockbox is designed to minimize cash theft losses. If the cost of the lockbox is less
than theft losses saved, then the lockbox should be installed.
D. Other things held constant, a firm will need a smaller line of credit if it can arrange to pay its
bills by the 5th of each month than if its bills come due uniformly during the month.
12. Which of the following actions would not be consistent with good management? (M)
A. Increased synchronization of cash flows.
B. Minimize the use of float.
C. Maintaining an average cash balance equal to that required as a compensating balance or that
which minimizes total cost.
D. Use of checks and drafts in disbursing funds.
13. The Baumol model determines the optimal cash balance by:
A. Balancing total costs against opportunity costs
B. Minimizing total costs of holding cash against trading securities costs
C. Balancing trading securities costs against total costs
D. Minimizing total costs less trading costs
14. When managing cash and short-term investments, a corporate treasurer is primarily concerned with
A. Liquidity & safety
B. Maximizing taxes.
C. Maximizing the rate of return.
D. Investing in Treasury bonds since they have no default mix.
15. Investment instruments used to invest temporarily idle cash balances should have the following
characteristics:
A. low default risk, low marketability, and a short term to maturity.
B. high expected return, readily marketable, and no maturity date.
C. low default risk, readily marketable, and a short term to maturity.
D. high expected return, low marketability, and a short term to maturity.

16. Which of the following investments generally pay the highest return?
A. Commercial paper C. Treasury bills
B. Money market accounts D. Treasury notes
17. All of the following are alternative marketable securities suitable for investment except
A. RP Treasury Bills C. Commercial paper
B. Eurodollars D. Convertible bonds
18. An enterprise's receivables collection period is equal to
A. The inventory conversion period. C. The day's sales outstanding.
B. The cash conversion cycle. D. The inventory divided by average daily sales.
19. Which of the following represents a firm’s average gross receivables balances?
I. Days’ sales in receivables x accounts receivable turnover.
II. Average daily sales x average collection period.
III. Net sales ÷average gross receivables.
A. I only. C. II only.
B. I and II only. D. II and III only.
20. An increase in the firm’s collection period means
A. the firm’s current ratio is increasing.
B. the firm’s collection expenses have fallen.
C. the firm’s receivables turnover ratio is increasing.
D. the firm has become less efficient in the collection of its receivables.
21. Which of the following statements is most correct? If a company lowers its DSO, but no changes
occur in sales or operating costs, then the company
A. might well end up with a lower debt ratio.
B. might well end up with a higher debt ratio.
C. would probably end up with a higher ROE.
D. total asset turnover ratio would probably decline.
22. A change in a seller’s credit policy has caused the following:
• Sales decreased • Investment in accounts receivable increased
• Discounts taken decreased • The number of doubtful accounts increased
Based on this information, we can say that
A. Net profit has decreased C. The average collection period has increased
B. Gross profit has increased D. The company increased the rate of discount
offered
23. Following are ways of accelerating collection of accounts receivables, except
A. shorten credit terms. C. age accounts receivables.
B. minimize negative float. D. offer special discounts to those who pay promptly
24. The carrying cost associated with inventory management includes
A. Insurance cost, shipping costs, storage costs, and obsolescence
B. Purchasing cost, shipping costs, set up costs, and quantity discount lost
C. Storage costs, handling costs, interest on capital invested and obsolescence
D. Obsolescence, set up costs, interest on capital invested, and purchasing order costs
25. The purpose of the economic order quantity model is to
A. Minimize the safety stock.
B. Minimize the inventory quantities.
C. Minimize the sum of the order costs and the holding costs.
D. Minimize the sum of the demand costs and the backlog costs.
26. The Economic Order Quantity (EOQ) formula does not assume that
A. usage is uniform C. the cost of inventory itself is constant
B. demand is known D. the cost of placing an order is constant
27. Which of the following is not an element in the EOQ formula?
A. periodic carrying cost per unit C. variable cost per order
B. safety stock D. yearly demand
28. The use of safety stock by a firm will
A. have no effect on inventory costs C. reduce inventory costs
B. increase inventory costs D. none of the given choices
29. Pepper Company changed from a traditional manufacturing philosophy to a just-in-time technology.
What are the expected effects of this change on Pepper’s inventory turnover and inventory as a
percentage of total assets reported on Pepper’s balance sheet?
A. B. C. D.
Inventory turnover Increase Increase Decrease Decrease
Inventory percentage Increase Decrease Increase Decrease

30. Which one of the following provides a spontaneous source of financing for a firm?
A. Accounts payable C. Debentures
B. Accounts receivable D. Mortgage bonds
31. The following forms of short-term borrowings are available to a firm:
• Floating lien • Bankers’ acceptances
• Factoring • Lines of credit
• Revolving credit • Commercial paper
• Chattel mortgages
The forms of short term borrowing that are unsecured credit are:
A. Factoring, chattel mortgage, bankers’ acceptances, and line of credit
B. Floating lien, chattel mortgage, bankers’ acceptances, and line of credit
C. Floating lien, revolving credit, chattel mortgages, and commercial paper
D. Revolving credit, bankers’ acceptances, line of credit, and commercial paper
32. Which of the following statements is most correct? (M)
A. Compensating balance requirements apply only to businesses, not to individuals.
B. Compensating balances are essentially costless to most firms, because those firms would
normally have such funds on hand to meet transactions needs anyway.
C. If the required compensating balance is larger than the transactions balance the firm would
ordinarily hold, then the effective cost of any loan requiring such a balance is increased.
D. Banks are prohibited from earning interest on the funds they force businesses to keep as
compensating balances.
33. A manufacturing firm wants to obtain a short-term loan and has approached several lending
institutions. All of the potential lenders are offering the same nominal interest rate, but the terms of
the loans vary. Which of the following combinations of loan terms will be most attractive for the
borrowing firm?
A. Simple interest, no compensating balance.
B. Discount interest, no compensating balance.
C. Simple interest, 20% compensating balance required.
D. Discount interest, 20% compensating balance required.
34. An example of secured short-term financing is:

A. A line of credit C. A warehouse receipt
B. A revolving credit line D. Commercial paper
35. A firm which finances through a factor
A. maintains a compensating balance.
B. uses inventory as collateral for a loan.
C. sells approved accounts receivable without recourse.
D. uses another company to guarantee a loan.

QUIZZER (DO-IT-YOURSELF DRILL)

THEORIES
1. Starrs Company has current assets of P300,000 and current liabilities of P200,000. Starrs could
increase its working capital by the
A. Prepayment of P50,000 of next year's rent.
B. Collection of P50,000 of accounts receivable.
C. Purchase of P50,000 of temporary investments for cash.
D. Refinancing of P50,000 of short-term debt with long-term debt.
2. Determining the appropriate level of working capital for a firm requires
A. Changing the capital structure and dividend policy for the firm.
B. Maintaining a high proportion of liquid assets to total assets in order to maximize the return on
total investments.
C. Offsetting the profitability of current assets and current liabilities against the probability of
technical insolvency.
D. Maintaining short-term debt at the lowest possible level because it is ordinarily more expensive
than long term debt.
E. Evaluating the risks associated with various levels of fixed assets and the types of debt used to
finance these assets.
3. Compared to other firms in the industry, a company that maintains a conservative working capital
policy will tend to have a
A. Higher total asset turnover.
B. Greater percentage of short-term financing.
C. Higher ratio of current assets to fixed assets.
D. Greater risk of needing to sell current assets to repay debt.
4. A firm following an aggressive working capital strategy would
A. Hold substantial amount of fixed assets.
B. Minimize the amount of short-term borrowing.
C. Finance fluctuating assets with long-term financing.
D. Minimize the amount of funds held in very liquid assets.
5. The working capital financing policy that subjects the firm to the greatest risk of being unable to meet
the firm’s maturing obligations is the policy that finances
A. Fluctuating current assets with long-term debt.
B. Fluctuating current assets with short-term debt.
C. Permanent current assets with long-term debt.
D. Permanent current assets with short-term debt.
6. Ignoring cost and other effects on the firm, which of the following measures would tend to reduce the
cash conversion cycle?
A. Take discounts when offered.
B. Forgo discounts that are currently being taken.
C. Maintain the level of receivables as sales decrease.
D. Buy more raw materials to take advantage of price breaks.
7. An increase in sales resulting from an increased cash discount for prompt payment would be expected
to cause
A. An increase in the operating cycle.
B. A decrease in purchase discounts taken.
C. A decrease in the cash conversion cycle.
D. An increase in the average collection period.
8. A precautionary motive for holding excess cash is
A. To enable a company to have cash to meet emergencies that may arise periodically.
B. To enable a company to meet the cash demands from the normal flow of business activity.
C. To enable a company to avail itself of a special inventory purchase before prices rise to higher
levels.
D. To avoid having to use the various types of lending arrangements available to cover projected
cash deficits.
9. The amount of cash that a firm keeps on hand in order to take advantage of any bargain purchases
that may arise is referred to as its
A. Compensating balance. C. Speculative balance.
B. Precautionary balance. D. Transactions balance.
10. Which of the following is not a major function in cash management?
A. Cash flow control C. Maximizing sales
B. Cash surplus investment D. Obtaining financing services

11. Which of the following actions would not be consistent with good management?
A. Minimize the use of float.
B. Increased synchronization of cash flows.
C. Use of checks and drafts in disbursing funds.
D. Maintaining an average cash balance equal to that required as a compensating balance or that
which minimizes total cost.
12. The following are desirable in cash management except:
A. Cash is collected at the earliest time possible.
B. Post-dated checks are not deposited on time upon maturity.
C. All sales are properly receipted and promptly deposited intact.
D. Most sales are on cash basis and receivables are aged “current”
13. A lock-box system
A. Accelerates the inflow of funds.
B. Provides security for late night deposits.
C. Reduces the need for compensating balances.
D. Reduces the risk of having checks lost in the mail.
14. All of the following are valid reasons for a business to hold cash and marketable securities except to
A. Meet future needs.
B. Satisfy compensating balance requirements.
C. Earn maximum returns on investment assets.
D. Maintain adequate cash needed for transactions.
15. When managing cash and short-term investments, a corporate treasurer is primarily concerned with
A. Minimizing taxes.
B. Liquidity and safety.
C. Maximizing rate of return.
D. Investing in Treasury bonds since they have no default risk.
16. Which of the following investments is not likely to be a proper investment for temporary idle cash?
A. Treasury bills.
B. Commercial paper.
C. Treasury bonds due within one year.
D. Initial public offering of an established profitable conglomerate.
17. The economic order quantity (EOQ) formula can be adapted in order for a firm to determine the
optimal mix between cash and marketable securities. The EOQ model assumes all of the following
except
A. Cash flow requirements are random.
B. The total demand for cash is known with certainty.
C. An opportunity cost is associated with holding cash, beginning with the first dollar.
D. The cost of a transaction is independent of the dollar amount of the transaction and interest
rates are constant over the short run.
18. The one item listed below that would warrant the least amount of consideration in credit and
collection policy decisions is the
A. Cash discount given. C. Quality of accounts accepted.
B. Quantity discount given. D. Level of collection expenditures.
19. The goal of credit policy is to
A. Maximize sales.
B. Minimize bad debt losses.
C. Minimize collection expenses.
D. Extend credit to the point where marginal profits equal marginal costs.
20. When a company analyzes credit applicants and increases the quality of the accounts rejected, the
company is attempting to
A. Maximize sales. C. Increase bad-debt losses.
B. Maximize profits. D. Increase the average collection period.
21. A strict credit and collection policy is in place in Star Co. As Finance Director you are asked to advise
on the propriety of relaxing the credit standards in view of stiff competition in the market. Your
advise will be favorable if
A. The competitor will do the same thing to prevent lost sales.
B. The projected margin from increased sales will exceed the cost of carrying the incremental
receivables.
C. The account receivable level is improving, so the company can afford the carrying cost of
receivables.
D. there is a decrease in the distribution level of your product, and a more aggressive stance in
necessary to retain market share.

22. It is held that the level of accounts receivable that the firm has or holds reflects both the volume of a
firm’s sales on account and a firm’s credit policies. Which one of the following items is not considered
as part of the firm’s credit policies?
A. The size of the discount that will be offered.
B. The length of time for which credit is extended.
C. The minimum risk group to which credit should be extended.
D. The extent (in terms of money) to which a firm will go to collect an account.
23. The credit and collection policy of Amargo Co. provides for the imposition of credit block when the
credit line is exceeded and/or the account is past due. During the month, because of the campaign to
achieve volume targets, the general manager has waived the credit block policy in a number of
instances involving big volume accounts. The likely effect of this move is
A. Increase in the level of receivables only.
B. Deterioration of aging of receivables only.
C. Deterioration of aging and increase in the level of receivables.
D. Decrease in collections during the month the move was done.
24. A high turnover of accounts receivable, which implies a very short days-sales outstanding, could
indicate that the firm
A. Offers small discounts.
B. Has a relaxed (lenient) credit policy.
C. Has an inefficient credit and collection department.
D. Uses a lockbox system, synchronizes cash flows, and has short credit terms.
25. Accounts receivable turnover will normally decrease as a result of
A. An increase in cash sales in proportion to credit sales.
B. A change in credit policy to lengthen the period for cash discounts.
C. A significant sales volume decrease near the end of the accounting period.
D. The write-off of an uncollectible account (assume the use of the allowance for doubtful accounts
method).
26. The level of accounts receivable will most likely increase as
A. Cash sales increase and number of says sales.
B. Credit limits are expanded, credit sales increase, and credit terms remain the same.
C. Credit limits are expanded, cash sales increase, and aging of the receivables is improving.
D. Cash sales increase, current receivables ratio to past due increases, credit limits remain the
same.
27. A change in credit policy has caused an increase in sales, an increase in discounts taken, a reduction
of the investment in accounts receivable, and a reduction in the number of doubtful accounts. Based
on this information, we know that:
A. Net profit has increased.
B. Gross profit has declined.
C. The average collection period has decreased.
D. The size of the discount offered has decreased.
28. If a firm had been extending trade credit on a 2/10, net/30 basis, what change would be expected on
the balance sheet of its customer if the firm went to a net cash 30 policy?
A. Decrease in cash. C. Decreased receivables.
B. Increased receivables. D. Increased payables and increased bank loan.
29. Which condition justifies accepting a low inventory turnover ratio?
A. High carrying costs. C. Low inventory order costs.
B. High stock-out costs. D. Short inventory order lead times.
30. If one optimizes the inventory turnover ratio, which costs will not increase?
A. Carrying costs C. Total reorder costs
B. Stock-out cost D. Unit reorder costs
31. Order-filling costs, as opposed to order-getting costs, include all but which of the following items?
A. Credit check of new customers.
B. Packing and shipping of sales orders.
C. Mailing catalogs to current customers.
D. Collection of payments for sales orders.
32. Which of the following inventory items would be the most frequently reviewed in an ABC inventory
control system?
A. Expensive, frequently used, high stock-out cost items with long lead time.
B. Expensive, frequently used, low stock-out cost items with long lead times.
C. Inexpensive, frequently used, high stock-out cost items with long lead time.
D. Expensive, frequently used, high stock-out cost items with short lead times.

33. In an ABC inventory analysis, the items that are most likely to be controlled with a red-line system
are the
A. A items. C. C items.
B. B items. D. items on a perpetual inventory.
34. The materials control method that is based on physical observation that an order point has been
reached is the:
A. ABC plan C. min-max method
B. cycle review method D. two-bin method
35. The underlying philosophy of “just-in-time” inventory system is that
A. The quantities of most stock items are subject to definable limits.
B. It is a quest toward continuous improvement in the environmental conditions that necessitates
inventories.
C. It is impractical to give equal attention to all stock items, hence the need to classify and rank
them according to their cost significance.
D. The status of quantities on hand must be periodically reviewed where high-value items or
critical items are examined more frequently than low-cost or non-critical items.
36. Companies that adopt just-in-time purchasing systems often experience
A. An increase in carrying costs.
B. Fewer deliveries from suppliers.
C. A reduction in the number of suppliers.
D. A greater need for inspection of goods as the goods arrive.
37. An inventory control system which employs mathematical models as an aid in making inventory
decision is known as
A. Mini-max system C. Statistical inventory control system.
B. Order cycling system D. Two-bin system
38. In inventory management, the problem of avoiding excessive investment in inventories and at the
same time avoiding inventory shortages can be solved by applying a quantitative technique known as
A. Payback analysis C. Probability analysis
B. Economic order quantity D. High-low point method
39. Which of the following is used in determining the economic order quantity (EOQ)?
A. Calculus. C. Queuing theory.
B. Markov process. D. Regression analysis.
40. A characteristic of the basic economic order quantity (EOQ) model is that it
A. Is relatively insensitive to error.
B. Is used when product demand, lead-time, and ordering costs are uncertain.
C. Should not be used in conjunction with computerized perpetual inventory systems.
D. Should not be used when carrying costs are large in relation to procurement costs.
41. In the Economic Order Quantity (EOQ) model, some of the underlying assumptions are
A. Constant demand, constant ordering cost, constant carrying cost, unlimited production and
inventory capacity.
B. Limited production capacity, declining demand, constant ordering cost, constant carrying cost,
and unlimited inventory capacity.
C. Increasing demand, limited production capacity, increasing ordering cost, increasing carrying
cost, and limited inventory capacity.
D. Unlimited production capacity, declining demand, decreasing ordering cost, decreasing carrying
cost, and unlimited inventory capacity.
42. The economic order quantity formula can be used to determine the optimum size of
A. B. C. D.
Production run Yes Yes No No
Purchase order Yes No Yes No
43. The simple economic production lot size model will only apply to situations in which the production
A. Rate equals the demand rate.
B. Rate is less than the demand rate.
C. Rate is greater than the demand rate.
D. For the period covered equals the projected sales for the period.
44. Which one of the following items is not directly reflected in the basic economic order quantity (EOQ)
model?
A. Inventory obsolescence.
B. Interest on invested capital.
C. Public warehouse rental charges.
D. Quantity discounts lost on inventory purchases.

45. The ______________ would not affect the economic order quantity.
A. cost of a stockout
B. cost of insuring inventory
C. cost of purchase requisition forms
D. company's weighted average cost of capital
46. The economic order quantity is not affected by the
A. safety stock level
B. cost of purchase-order forms.
C. cost of insuring a unit of inventory for a year.
D. estimate of the annual material consumption.
47. The ordering costs associated with inventory management include
A. Insurance costs, purchasing costs, shipping costs, and obsolescence.
B. Obsolescence, set up costs, quantity discounts lost, and storage costs.
C. Purchasing costs, shipping costs, set-up costs, and quantity discounts lost.
D. Quantity discounts lost, storage costs, handling costs, and interest on capital invested.
48. The carrying costs pertaining to inventory include
A. Insurance costs, incoming freight costs and setup costs.
B. Insurance costs, incoming freight costs and storage costs.
C. Setup costs and opportunity cost of capital invested in inventory.
D. Storage costs and opportunity cost of capital invested in inventory.
49. The optimal level of inventory is affected by all of the following except the
A. Cost per unit of inventory.
B. Current level of inventory.
C. Usage rate of inventory per time period.
D. Cost of placing an order for merchandise.
50. A change from the FIFO (first-in, first-out) inventory valuation method to the LIFO (last-in, first-out)
method would
A. Not affect the EOQ.
B. Increase the EOQ in times of rising prices.
C. Increase the EOQ in times of falling prices.
D. Decrease the EOQ in times of rising prices.
51. The selling price of the product is relatively high and the purchase cost of the product is relatively
low. In this situation
A. The EOQ model will indicate frequent large orders.
B. The EOQ of the product is affected by the selling price.
C. The selling price has nothing to do with the EOQ of the product.
D. Management must increase the price to cover the cost of carrying higher inventory.
52. Clear View Co. manufactures various glass products including a car window. The setup cost to
produce the car window is P1,200. The cost to carry a window in inventory is P3 per year. Annual
demand for the car window is 12,000 units. If the annual demand for the car window was to increase
to 15,000 units,
A. the number of setups would decrease.
B. the total carrying costs would increase.
C. the economic order quantity would decline.
D. all of the above would occur.
53. A decrease in inventory order costs will
A. Increase the reorder point.
B. Decrease the economic order quantity.
C. Decrease the holding cost percentage.
D. Have no effect on the economic order quantity.
54. An increase in inventory holding costs will
A. Increase the economic order quantity.
B. Decrease the economic order quantity.
C. Have no effect on the economic order quantity.
D. Decrease the number of orders issued per year.
55. The economic order quantity (EOQ) will rise following
A. An increase in carrying costs.
B. A decrease in annual unit sales.
C. An increase in the per unit purchase price of inventory.
D. An increase in the variable costs of placing and receiving an order.

56. For its economic order quantity model, a company has a P10 cost of placing an order and a P2 annual
cost of carrying one unit in stock. If the cost of placing an order increases by 20%, the annual cost of
carrying one unit in stock increases by 25%, and all other considerations remain constant, the
economic order quantity will:
A. decrease
B. increase
C. remain unchanged
D. either increase or decrease, depending on the reorder point
E. either increase or decrease, depending on the safety stock
57. Missile Company has correctly computed its economic order quantity as 500 units. However,
management feels it would rather order quantities of 600 units. How should Missile’s total annual
purchase-order costs and total annual carrying cost for an order quantity of 600 units compare to the
respective amounts for an order quantity of 500 units?
A. Lower purchase-order cost and lower carrying cost.
B. Lower purchase-order cost and higher carrying cost.
C. Higher purchase-order cost and lower carrying cost.
D. Higher purchase-order cost and higher carrying cost.
58. When a specific level of safety stock is carried for an item in inventory, the average inventory level
for that item
A. Is not affected by the safety stock.
B. Increases by the amount of the safety stock.
C. Decreases by the amount of the safety stock.
D. Increases by one-half the amount of the safety stock.
59. For inventory management, ignoring safety stocks, which of the following is a valid computation of
the reorder point?
A. The economic order quantity.
B. The square root of the anticipated demand during the lead time.
C. The anticipated demand per day during lead time times lead time in days.
D. The economic order quantity times the anticipated demand during the lead time.
60. The cost of stock-out do not include
A. Depreciation and obsolescence. C. Loss of customer goodwill.
B. Disruption of production schedules. D. Loss of sales.
61. For a 300-day work year Kulasa Corp. consumes 420,000 units of an inventory item. The usual lead-
time for the inventory item is six (6) days; however, at times, the lead-time has gone as high as
eight (8) days. Kulasa now desires to adjust its safety stock policy. The likely effect on stockout
costs and carrying costs, respectively, would be
A. Increase and increase. C. Decrease and increase.
B. Increase and decrease. D. Decrease and decrease.
62. The optimal safety stock level is the quantity of safety stock that minimizes the sum of the annual
relevant
A. ordering costs and carrying costs. C. ordering costs and stockout costs.
B. ordering costs and purchasing costs. D. stockout costs and carrying costs.
63. A company obtaining short-term financing with trade credit will pay a higher percentage financing
cost, everything else being equal, when
A. The discount percentage is lower.
B. The items purchased have a lower price.
C. The items purchased have a higher price.
D. The supplier offers a longer discount period.
64. Merkle, Inc. has a temporary need for funds. Management is trying to decide between not taking
discounts from one of their three biggest suppliers, or a 14.75% per annum renewable discount loan
from its bank for 3 months. The suppliers' terms are as follows:
Fort Co. 1/10, net 30
Riley Manufacturing Co. 2/15, net 60
Shad, Inc. 3/15, net 90
Using a 360-day year, the cheapest source of short-term financing in this situation is
A. Fort Co. C. Shad, Inc.
B. Riley Manufacturing Co. D. The bank.
65. In assessing the loan value of inventory, a banker will normally be concerned about the portion of
inventory that is work-in-process because
A. WIP generally has the lowest marketability of the various types of inventories.
B. WIP inventory usually has the highest loan value of the different inventory types.
C. WIP represents a lower investment by a corporation as opposed to other types of inventories.
D. WIP inventory is relatively easy to sell because it does not represent a raw material or a finished
product.

66. A company is arranging debt financing for the purchase of a new piece of equipment that has a 5-
year expected useful life. Which of the following alternative financing arrangements has the lowest
effective annual percentage rate if each has a quoted nominal rate of 9.5%?
A. A 5-year term loan with interest compounded annually.
B. A 10-year term loan with interest compounded semiannually.
C. A 5-year term loan with interest compounded quarterly.
D. A 10-year term loan with interest compounded monthly.
67. Commercial paper
A. Has a maturity date greater than 1 year.
B. Is usually sold only through investment banking dealers.
C. Ordinarily does not have an active secondary market.
D. Has an interest rate lower than Treasury bills.
68. Large companies often raise short-term debt by selling:
A. Bonds C. Medium term notes
B. Debentures D. Commercial paper
69. A one year, P20,000 loan with a 10% nominal interest rate provides the borrower with the use of
<List A> if interest is charged on a <List B> basis. (E)
A. B. C. D.
List A P18,000 P20,000 P20,000 P22,000
List B Simple Simple Discount Discount
70. A small retail business would most likely finance its merchandise inventory with
A. Commercial paper. C. A line of credit.
B. A terminal warehouse receipt loan. D. A chattel mortgage.
PROBLEMS
1. AATROX ENTERPRISES is considering whether to pursue a restricted or relaxed current asset
investment policy. The firm’s annual sales are P400,000; its fixed assets are P100,000; debt and
equity are each 50 percent of total assets. EBIT is P36,000, the interest rate on the firm’s debt is 10
percent, and the firm’s tax rate is 40 percent. With a restricted policy, current assets will be 15
percent of sales. Under a relaxed policy, current assets will be 25 percent of sales. What is the
difference in the projected ROEs between the restricted and relaxed policies?
A. 1.6% C. 5.4%
B. 3.8% D. 6.2%
SOLUTION:
Restricted Relaxed
Fixed Asset 100,000 100,000
Current Asset (Restricted: 400k x 15%;
Relaxed: 400k x 25%) 60,000 100,000
TOTAL ASSET 160,000 200,000
Debt (Total Asset x 50%) 80,000 100,000

Equity (Total Asset x 50%) 80,000 100,000
TOTAL 160,000 200,000
Earnings Before Interest and Tax 36,000 36,000

Interest Rate (Debt x 10%) 8,000 10,000
Earnings Before Tax 28,000 26,000
Tax Rate (Earnings Before Tax x 40%) 11,200 10,400
Net Income 16,800 15,600
ROE (Net Income/Equity) 21% 15.6%

Differences = 5.4%
Restricted Relaxe
Fixed Assets
100,000

100,000
Current Assets (Restricted
400,000*15%) (Relaxed
400,000*25%)
60,000
100,000
Total Asset
160,000
200,000
Debt
80,000
100,000
Equity
80,000
100,000
Earnings before Intertest and Tax

36,000
36,000
Interest (10%)
8,000
10,000
Earnings before Tax
28,000
26,000
Tax Rate (40%)
11,200
10,400
Net Income
16,800
15,600
Equity
80,000
100,000
ROE 21%
Difference ROE between the
restricted and relaxed 5.4%
2. AHRI CORP.’s total assets fluctuate between P320,000 and P410,000, while its fixed assets remain
constant at P260,000. If the firm follows a maturity matching or moderate working capital financing
policy, what is the likely level of its long-term financing?
A. P 90,000 C. P320,000
B. P260,000 D. P410,000
SOLUTION:
410,000 – 320,000 = 90,000 - fluctuated amount
410,000 – 90,000 = 320,000 (total asset) – 260,000 (fixed asset) = 60,000 (current asset)
*current asset = working capital (for financial analyst)
LONG TERM DEBT = 260,000
WORKING CAPITAL = 60,000
DEBT AND EQUITY = 320,000
3. AKALI CORP. purchases raw materials on July 1. It converts the raw materials into inventory by
September 30. However, AKALI pays for the materials on July 20. On October 31, it sells the finished
goods inventory. Then, the firm collects cash from the sale 1 month later on November 30. If this
sequence accurately represents the average working capital cycle, what is the firm's cash conversion
cycle in days?
A. 92 days. C. 133 days.
B. 123 days. D. 153 days.
SOLUTION:
CCC = ICP + ACP – PDP
CCC = 92 days + (31 days +30 days) - 20 days
CCC = 133 days
4. ALISTAR COMPANY writes checks averaging P15,000 a day, and it takes five days for these checks to
clear. The firm also receives checks in the amount of P17,000 per day, but the firm loses three days
while its receipts are being deposited and cleared. What is the firm’s net float in dollars?
A. P 24,000 C. P 75,000
B. P 32,000 D. P126,000
5. What is the opportunity cost of keeping a cash balance of P2 million, if the daily interest rate is 0.02%
and the average transaction cost of investing money overnight is P50?
A. P50 C. P400
B. P350 D. P40,000
Questions 6 and 7 are based on the following information.
AMUMU INC. has a 10% cost of borrowing and incurs fixed costs of P500 for obtaining a loan. It has
stable, predictable cash flows, and the estimated total amount of net new cash needed for
transactions for the year is P175,000. The company does not hold safety stocks of cash.
6. When the average cash balance of the company is higher, the <List A> the cash balance is <List B>.
List A List B
A. Opportunity cost of holding Higher
B. Total transactions costs associated with obtaining Higher
C. Opportunity cost of holding Lower
D. Total costs of holding Lower
7. If the average cash balance for the company during the year is P20,916.50, the opportunity cost of
holding cash for the year will be
A. P2,091.65 C. P8,750.00
B. P4,183.30 D. P17,500.00
8. ANIVIA CORP. is a retail mail order firm that currently uses a central collection system that requires
all checks to be sent to its Boston headquarters. An average of 5 days is required for mailed checks to
be received, 4 days for ANIVIA to process them and 1½ days for the checks to clear through its bank.

A proposed lockbox system would reduce the mail and process time to 3 days and the check clearing
time to 1 day. ANIVIA has an average daily collection of P100,000. If ANIVIA should adopt the
lockbox system, its average cash balance would increase by
A. P250,000. C. P650,000.
B. P400,000. D. P800,000.
9. What are the expected annual savings from a lockbox system that collects 200 checks per day
averaging P500 each, and reduces mailing and processing times by 2.0 and 0.5 days, respectively, if
the annual interest rate is 6%?
A. P6,000 C. P15,000
B. P12,000 D. P250,000
10. A company has daily cash receipts of P150,000. The treasurer of the company has investigated a
lock box service whereby the bank that offers this service will reduce the company’s collection time
by four days at a monthly fee of P2,500. If money market rates average 4% during the year, the
additional annual income (loss) from using the lock box service would be
A. P(12,000). C. P6,000.
B. P(6,000). D. P12,000.
11. A banker has offered to set up and operate a lock box system for your company. Details are given
below.
Average number of daily payments 325
Average size of payments P1,250
Daily interest rate 0.021%
Saving in mailing time 1.3 days
Saving in processing time 0.9 days
Bank charges P0.30
Estimate the annual savings. Assume 250 processing days per year.
A. P3,273 C. P23,500
B. P22,675 D. P47,000
12. ANNIE INC. makes large cash payments averaging P17,000 daily. The company changed from using
checks to sight drafts which will permit it to hold unto its cash for one extra day. If ANNIE can use
the extra cash to earn 14% annually, what annual peso return will it earn?
A. P6.52 C. P2,380
B. P652.10 D. P6,521.00
Questions 13 and 14 are based on the following information.
ASHE INC. has P2 million invested in Treasury bills yielding 8% per annum; this investment will
satisfy the firm's need for funds during the coming year.
13. If it costs P50 to sell these bills, regardless of the amount, how much should be withdrawn at a time?
A. P50,000 C. P250,000
B. P100,000 D. P500,000
14. If ASHE INC. needs P167,000 a month, how frequently should the CFO sell off Treasury bills?
A. About every 3 days. C. About every 15 days.
B. About every 9 days. D. About every 18 days.
15. AURELION SOL INC. sells on terms of 3/10, net 30 days. Gross sales for the year are P2,400,000 and
the collections department estimates that 30% of the customers pay on the 10th day and take
discounts; 40% pay on the 30th day; and the remaining 30% pay, on the average, 40 days after the
purchase. Assuming 360 days per year, what is the average collection period.
A. 15 days. C. 27 days.
B. 20 days. D. 40 days.
16. Sixty percent of AZIR CORP.'s annual sales of P900,000 is on credit. If its year-end receivables
turnover is 4.5, what is the average collection period and the year-end receivables, respectively
(assume a 365-day year)?
A. 73 days and P108,000. C. 81 days and P120,000.
B. 73 days and P120,000. D. 81 days and P200,000.
17. BARD CORP. believes that its collection costs could be reduced through modification of collection
procedures. This action is expected to result in a lengthening of the average collection period from 30
to 35 days; however, there will be no change in uncollectible accounts, or in total credit sales.
Furthermore, the variable cost ratio is 60%, the opportunity cost of a longer collection period is
assumed to be negligible, the company's budgeted credit sales for the coming year are P45,000,000,
and the required rate of return is 6%. To justify changes in collection procedures, the minimum
annual reduction of costs (using a 360-day year and ignoring taxes) must be
A. P22,500 C. P125,000

B. P37,500 D. P375,000
18. BLITZCRANK CORP. has an inventory conversion period of 60 days, a receivable conversion period of
35 days, and a payment cycle of 26 days. If its sales for the period just ended amounted to
P972,000, what is the investment in accounts receivable? (Assume 360 days a year.)
A. P72,450 C. P85,200
B. P79,600 D. P94,500
19. BRAND COMPANY plans to tighten its credit policy. Below is the summary of changes:
Old New
Average number of days collection 75 50
Ratio of credit sales to total sales 70% 60%
Projected sales for the coming year is P100 million and it is estimated that the new policy will result in
a 5% loss if the new policy is implemented. Assuming a 360-day year, what is the effect of the new
policy on accounts receivable?
A. No change. C. Decrease of P 6.67 million.
B. Decrease of P5 million. D. Decrease of P13 million.
20. BRAUM CORP. whose gross sales amounted to P1,200,000 sold on terms of 3/10, net 30. The
collections manager estimated that 30% of the customers pay on the 10th day and take discounts;
40% on the 30th day; and the remaining 30% pay, on the average, 40 days after the purchase. If
management would toughen on its collection policy and require that all non-discount customers pay
on the 30th day, how much would be the receivables balance?
A. Zero C. P70,000
B. P60,000 D. P80,000
21. CAITLYN CO.’s budgeted sales for the coming year are P96 million, of which 80% are expected to be
credit sales at terms of n/30. The company estimates that a proposed relaxation of credit standards
would increase credit sales by 30% and increase the average collection period form 30 days to 45
days. Based on a 360-day year, the proposed relaxation of credit standards would result to an
increase in accounts receivable balance of
A. P1,920,000 C. P6,080,000
B. P2,880,000 D. P6,880,000
22. CAMILLE CO. buys on terms of 2/15, net 30. It does not take discounts, and it typically pays 30 days
after the invoice date. Net purchases amount to P720,000 per year. On average, how much “free”
trade credit does CAMILLE receive during the year? (Assume a 360-day year.)
A. P30,000 C. P50,000
B. P40,000 D. P60,000
23. CASSIOPEIA MART has sales of P3 million. Its credit period and average collection period are both 30
days and 1% of its sales end as bad debts. The general manager intends to extend the credit period
to 45 days which will increase sales by P300,000. However, bad debts losses on the incremental
sales would be 3%. Costs of products and related expenses amount to 40% exclusive of the cost of
carrying receivables of 15% and bad debts expenses. Assuming 360 days a year, the change in
policy would result to incremental investment in receivables of
A. P9,750. C. P65,000.
B. P24,704. D. P701,573
24. The CHO’GATH CORP.’s budgeted sales for the coming year are P30 million of which 80% are
expected to be on credit. The company wants to change its credit terms from n/30 to 2/10, n/30. If
the new credit terms are adopted, the company estimates that cash discounts would be taken on
40% of the credit sales and the new uncollectible amount would be unchanged. The adoption of the
new credit terms would result in expected discount availed of in the coming year of
A. P192,000 C. P480,000
B. P288,000 D. P600,000
25. MR. CORKI assumed the presidency of DARIUS CORP. He instituted new policies and with respect to
credit policy, below is a summary of relevant information:
Old Credit Policy New Credit Policy
Sales P1,800,000 P1,980,000
Average collection period 30 days 36 days
The company requires a rate of return of 10% and a variable cost ratio of 60%.
Using a 360-day year, the pre-tax cost of carrying the additional investment in receivables under the
new policy would be
A. P2,880 C. P4,080
B. P3,000 D. P4,800
26. The Sales Director of DIANA CORP. suggests that certain credit terms be modified. He estimates the
following effects:
 Sales will increase by at least 20%.
 Accounts receivable turnover will be reduced to 8 times from the present turnover of 10 times.

 Bad debts, now at 1% of sales will increase to 1.5%. Sales before the proposed changes is at
P900,000. Variable cost ratio is 55% and desired rate of return is 20%. Fixed expenses
amount to P150,000.
Should the company allow the revision of its credit terms?
A. No, because losses will increase by P28,000.
B. Yes, because income will increase by P68,850.
C. No, because income will be reduced by P13,000.
D. Yes, because losses will be reduced by P78,800.
27. DR. MUNDO INC. has annual credit sales of P4 million. Its average collection period is 40 days and
bad debts are 5% of sales. The credit and collection manager is considering instituting a stricter
collection policy, whereby bad debts would be reduced to 2% of total sales, and the average
collection period would fall to 30 days. However, sales would also fall by an estimated P500,000
annually. Variable costs are 60% of sales and the cost of carrying receivables is 12%. Assuming a
tax rate of 35% and 360 days a year, the incremental change in the profitability of the company if
stricter policy would be implemented would be
A. A reduction in net income by P35,400.
B. A reduction in net income by P38,350.
C. A reduction in net income by P70,000.
D. Zero as the positive and negative effects offset each other.
28. DRAVEN INC. has the opportunity to increase annual sales by P1 million by selling to new riskier
customers. It has been estimated that uncollectible expenses would be 15% and collection costs 5%.
The manufacturing and selling costs are 70% of sales and corporate tax is 35%. If it pursues this
opportunity, the after tax profit will
A. Remain the same. C. Increase by P65,000.
B. Increase by P35,000. D. Increase by P97,500.
29. A firm currently sells P500,000 annually with 3% bad debt losses. Two alternative policies are
available. Policy A would increase sales by P500,000, but bad debt losses on additional sales would be
8%. Policy B would increase sales by an additional P120,000 over Policy A and bad debt losses on the
additional P120,000 of sales would be 15%. The average collection period will remain at 60 days (6
turns per year) no matter the decision made. The profit margin will be 20% of sales and no other
expenses will increase. Assume an opportunity cost of 20%. What should the firm do?
A. Make no policy change.
B. Change to only Policy A.
C. Change to Policy B (means also taking Policy A first).
D. All policies lead to the same total firm profit, thus all policies are equal.
30. A firm that often factors its accounts receivable has an agreement with its finance company that
requires the firm to maintain a 6% reserve and charges 1% commission on the amount of
receivables. The net proceeds would be further reduced by an annual interest charge of 10% on the
monies advanced. Assuming a 360-day year, what amount of cash (rounded to the nearest dollar) will
the firm receive from the finance company at the time a P100,000 account that is due in 90 days is
turned over to the finance company?
A. P83,700 C. P90,675
B. P90,000 D. P93,000
Questions 31 through 33 are based on the following information.
EKKO INC.’s credit manager studied the bill-paying habits of its customers and found that 90% of
them were prompt. She also discovered that 22% of the slow payers and 5% of the prompt ones
subsequently defaulted. The company has 3,000 accounts on its books, none of which has yet
defaulted.
31. Calculate the total number of expected defaults, assuming no repeat business is on the horizon.
A. 66 C. 201
B. 135 D. 795
32. Given average revenues from sales of P1,200 and the cost of sales of P1,100, what is the average
expected profit or loss from extending credit to slow payers?
A. P100 profit. C. P220 loss.
B. P164 loss. D. P264 loss.
33. Given revenues from sales of P1,200 and the cost of sales of P1,100, what would the average level of
revenues that makes it worthwhile to extend credit to slow payers?
A. P1,364.00 C. P1,410.26
B. P1,389.74 D. P1,510.26
34. The following data refer to various annual costs relating to the inventory of a single-product
company:
Unit transportation-in on purchases P0.20
Storage per unit 0.12

Insurance per unit 0.10

Annual interest foregone from alternate investment of funds P800
Annual number of units required 10,000
What is the annual carrying cost per unit?
A. P0.30 C. P0.42
B. P0.32 D. P0.50
35. ELISE COMPANY is a distributor of videotapes. EVELYNN CORP. is a local retail outlet which sells blank
and recorded videos. EVELYNN CORP. purchases tapes from ELISE COMPANY at P3.00 per tape; tapes
are shipped in packages of 20. ELISE pays all incoming freight, and EVELYNN does not inspect the
tapes due to ELISE’s reputation for high quality. Annual demand is 104,000 tapes at a rate of 4,000
tapes per week. EVELYNN earns 20% on its cash investments. The purchase-order lead time is two
weeks. The following cost data are available:
Relevant ordering costs per purchase order P90.50
Carrying costs per package per year:
Relevant insurance, materials handling, breakage, etc., per year P 4.50
What is the required annual return on investment per package?
A. P0.60 C. P12.00
B. P2.50 D. P60.00
36. EZREAL CORP. manufactures winter jackets. Setup costs are P2.00. EZREAL manufactures 4,000
jackets evenly throughout the year. Using the economic order quantity approach, the optimal
production run would be 200 when the cost of carrying one jacket in inventory for one year is:
A. P0.05 C. P0.20
B. P0.10 D. P0.40
37. A company has estimated its economic order quantity for Part A at 2,400 units for the coming year. If
ordering costs are P200 and carrying costs are P0.50 per unit per year, what is the estimated total
annual usage?
A. 2,400 units C. 7,200 units
B. 6,000 units D. 28,800 units
38. The following information are given:
Optimal production run in units 2,000
Average inventory in units 1,000
Number of production runs 5
Cost per unit produced P75
Desired annual return on inventory investment 18%
Set-up costs per production run P5,000
If the units will be required evenly throughout the year, the total annual relevant costs using the
economic-order-quantity approach is
A. P5,000 C. P75,000
B. P38,500 D. P150,000
39. One of the products that FIDDLESTICKS CORP. sells is a magnetic back support. The ordering cost
related to this product is P12.50 per order. The cost of carrying one item of inventory for one year is
P16.00. The business sells 40,000 of this type of product evenly throughout the year. How much is
the total ordering costs per year and the total carrying costs per year at the economic order quantity?
A. B. C. D.
Ordering costs P1,562.50 P1,562.50 P2,000.00 P4,000.00
Carrying costs P1,562.50 P2,560.00 P2,000.00 P4,000.00
40. The economic order quantity is the size of the order that minimizes total inventory costs, including
ordering and carrying costs. If the annual demand decreases by 36%, the optimal order size will
A. Decrease by 6%. C. Increase by 6%.
B. Decrease by 20%. D. Increase by 20%.
41. As a consequence of finding a more dependable supplier, FIORA CORP. reduced its safety stock of raw
materials by 80%. What is the effect of this safety stock reduction on Dee’s economic order quantity.
A. No effect. C. 64% decrease.
B. 20% increase. D. 80% decrease.
42. FIZZ CO.’s financial plan for next year shows sales of P72 million and cost of sales of P45 million. It
expects short term interest rates to average 10% for the coming year. It aims to increase inventory
turnover from the present level of 9 times to 12 times next year. If its plans and objectives would be
carried out, how much is the cost savings for the coming year?
A. P125,000 C. P375,000
B. P300,000 D. P500,000
43. GALIO works for a local ceramics company. She just completed her accountancy degree and learned
the EOQ model in one of her subjects. She suggested to her employer to adopt it. The company sells
20,000 pieces of specialty ceramic items each year. Traditionally, they have produced these items

four times a year, making 5,000 pieces at a time. They carry no safety stock as customers do not
mind waiting for orders. The average piece of ceramic items costs P400 to make and costs the
company P20 to carry in inventory for a year. The set up costs for each production run total P80.
The company should
A. Adopt EOQ due to savings of P35,675.
B. Adopt EOQ due to savings of P42,320.
C. Continue the existing system due to P38,950 advantage.
D. Continue the existing system due to P41,820 advantage.
44. GANGPLANK INC. currently places orders for a particular stock item at quarterly intervals.
Information concerning this item is as follows:
Cost of placing an order P10
Annual demand 20,000 units
Purchasing price per unit P0.50
The cost of holding the stock items amounts to 20% of the stock value per annum.
What annual cost saving would result if GANGPLANK used the economic order quantity for order sizes
instead of their current policy?
A. P 80 C. P150
B. P 90 D. P240
45. A company annually consumes 10,000 units of Part C. The carrying cost of this part is P2 per year
and the ordering costs are P100. The company uses an order quantity of 500 units. By how much
could the company reduce its total costs if it purchased the economic order quantity instead of 500
units?
A. P0 C. P2,000
B. P500 D. P2,500
46. For Raw Material B, a company maintains a safety stock of 5,000 pounds. Its average inventory
(taking into account the safety stock) is 8,000 pounds. What is the apparent order quantity?
A. 6,000 lbs. C. 16,000 lbs.
B. 10,000 lbs. D. 21,000 lbs.
47. GAREN CORP. consumes 300,000 units of spare part V per year. The average purchase lead time is
20 working days while the maximum is 27 working days. The company’s annual operations cover 240
days allowing for shutdowns for plant maintenance, holidays and Sundays. The company would like
to keep safety stock or extra stock to guard against stock-outs. How much is the safety stock?
A. 1,250 units. C. 25,000 units.
B. 8,750 units. D. 33,750 units.
48. GNAR CO. uses 840,000 units of component R4 in manufacturing R444 over a 300-day work year.
The usual lead time for the part is six days. However, at times, the lead time has gone as high as
eight days. Scholas now desires to adjust its safety stock policy. The increase in safety stock size is
A. 2,800 units. C. 7,200 units.
B. 5,600 units. D. 16,800 units.
49. An organization has an inventory order quantity of 10,000 units and a safety stock of 2,000 units.
The cost per unit of inventory is P5, and the carrying cost is 10% of the average value of inventory.
The annual inventory carrying cost for the organization is
A. P3,000 C. P5,000
B. P3,500 D. P6,000
50. GRAGAS CORP. order quantity for Material T is 5,000 lbs. If the company maintains a safety stock of
T at 500 lbs., and its order point is 1,500 lbs., what would be the total annual carrying costs
assuming the carrying cost per unit is P0.20?
A. P100 C. P1,000
B. P600 D. P1,100
51. GRAVES CORP. is a business enterprise located in the city of Cagayan de Oro. The market price per
unit is P3,000. Since Cagayan de Oro is a very progressive rural place, the business sells an average
of 36,000 tires annually. Based on a company study covering the last five years of its operation, it
was found out that annual carrying cost per tire is P5.00 and the ordering cost is P100 per order. The
store is open 7 days a week (which includes Sundays and holidays). The delivery time per order
(tires are ordered from Manila) is 5 days. Since it normally takes time before an order is placed, filled
up and delivered, the manager has decided to keep a safety stock of 3,000 tires which is equivalent
to a month’s sales. The average inventory is
A. 1,200 tires C. 3,493 tires
B. 3,000 tires D. 3,600 tires
52. HECARIM INC.’s order quantity for Material T is 5,000 lbs. If the company maintains a safety stock of
T at 500 lbs., and its order point is 1,500 lbs., what is the lead time assuming daily usage is 50 lbs.?
A. 10 days C. 30 days
B. 20 days D. 100 days

53. Information regarding the usage of material Y which shall be required evenly throughout the year by
HEIMERDINGER CORP.
Annual usage in units 30,000
Working days per year 250
Safety stock in units 1,200
Normal lead time in working days 25
The re-order point is
A. 3,000 C. 5,700
B. 4,200 D. 6,250
54. ILLAOI CO. has the following information on inventory:
Sales 20,000 units per year
Order quantity 4,000 units
Safety stock 2,600 units
Lead time 4 weeks
What is the re-order point? (For calculation purposes, use 50-week year)
A. 1,600 units. C. 4,200 units.
B. 2,600 units. D. 5,600 units.
55. The IRELIA STORE sells 100,000 tea bags a year. Additional data are presented below:
Selling price per bag P2.50
Purchase cost per bag P1.50
Ordering cost per order P5.40
Carrying cost 20% of unit cost
Number of days the company operates in a year 250
Average lead time on purchases 6 days
What is the reorder point if the company will keep a 10-day safety stock of inventory?
A. 2,400 bags C. 6,400 bags
B. 5,400 bags D. 8,800 bags
56. IVERN INC. gathered the following information related to one of its materials:
Order quantity 1,500 units
Normal use per day 500 units
Maximum use per day 600 units
Minimum use per day 100 units
If the lead time is five days, the order point is
A. 500 units C. 2,500 units
B. 1,500 units D. 3,000 units
57. Inventory data for a certain raw material is as follows:
Annual usage in units 25,000
Working days per year 250
Normal lead time in working days 30
Maximum lead time in working days 50
Assuming that this raw material will be required evenly throughout the year, the order point will be
A. 3,000 C. 5,000
B. 4,000 D. 8,000
58. A softdrinks distributor which buys in a pre-sell basis, is discussing with the route salesmen on the
proper cases to be ordered and the frequency of call. From the route book and other records, the
following are available: prior year’s purchases, 50,000 cases; carrying cost per case of inventory,
P1.20; distributor’s discount, 1 case for every 10 cases bought; cost of placing an order, P3.00;
weekly demand is approximately 962 cases. Safety stock required is 140 cases. No change in
demand is expected this year. (Use a 365-day, 52-week year).
A. B. C. D.
EOQ 250 cases 481 cases 500 cases 962 cases
Reorder point 280 cases 500 cases 414 cases 275 cases
59. If JANNA COMPANY has a safety stock of 160 units and the average daily demand is 20 units, how
many days can be covered if the shipment from the supplier is delayed by 12 days?
A. 6.7 days C. 10.0 days
B. 8.0 days D. 12.0 days
60. Each stockout of PRODUCT XY sold by JARVAN IV CORP. costs P87,500 per occurrence. The carrying
cost per unit of inventory is P250 per year, and the company orders 1,500 units of product 24 times a
year at a cost of P5,000 per order. The probability of stockout at various levels of safety stock is
Units of Safety Stock Probability of a stockout
0 0.50

100 0.30
200 0.14
300 0.05
400 0.01
The optimal safety stock level for the company is
A. 0 units. C. 300 units.
B. 100 units. D. 400 units.
61. JAX CORP. seeks to determine the quantity of safety stock for product ST that they should maintain
that will result in the lowest cost to the company. Each stockout will cost P600 and the carrying cost
of each unit of safety stock will be P8. Product ST will be ordered five times a year. Which of the
following will produce the lowest cost?
A. A safety stock of 15 units which is associated with a 35% probability of running out of stock
during an order period.
B. A safety stock of 25 units which is associated with a 25% probability of running out of stock
C. A safety stock of 35 units which is associated with a 10% probability of running out of stock
D. A safety stock of 75 units associated with a 5% probability of running out of stock during an
order period.
62. JAYCE ENTERPRISES uses the EOQ model for inventory control. The company has an annual demand
of 50,000 units for part number 101 and has computed an optimal lot size of 6,250 units. Per-unit
carrying costs and stockout costs are P13 and P3, respectively. The following data have been
gathered in an attempt to determine an appropriate safety stock level:
Units Short Because of Excess Number of Times Short
Demand during the Lead Time Period in the last 40 Reorder Cycles
200 6
300 12
400 6
The annual cost of establishing a 200-unit safety stock is expected to be
A. P2,600 C. P4,040
B. P4,260 D. P5,200
63. JHIN INC. purchases merchandise from a company that gives sales terms of 2/15, net 40. JIN has
gross purchases of P800,000 per year. What is the maximum amount of costly trade credit JIN could
get, assuming they abide by the suppliers credit terms? (Assume a 360-day year.)
A. P32,666.70 C. P54,444.50
B. P52,266.67 D. P87,111.20
64. On cash discounts, all of the following statements do not apply except
A. The cost of not taking a cash discount is always higher than the cost of a bank loan.
B. The cost of not taking the discount is higher for terms of 2/10, net 60 than for 2/10, net 30.
C. With trade terms of 2/15, net 60, if the discount is taken the buyer receive 45 days of credit.
D. If a firm buys P10,000 of goods on terms of 1/10, net 30 and pays within the discount period,
the amount paid would be P9,000.
65. Suppose the credit terms offered to your firm by your suppliers are 2/10, net 30 days. Out of
convenience, your firm is not taking discounts, but is paying after 20 days, instead of waiting until
Day 30. You point out that the nominal cost of not taking the discount and paying on Day 30 is
around 37 percent. But since your firm is not taking discounts and is paying on Day 20, what is the
effective annual cost of your firm’s current practice, using a 360-day year?
A. 36.7% C. 106.9%
B. 73.4% D. 43.6%
66. Your firm buys on credit terms of 2/10, net 45, and it always pays on Day 45. If you calculate that
this policy effectively costs your firm P157,500 each year, what is the firm’s average accounts
payable balance?
A. P157,500 C. P750,000
B. P625,000 D. P1,234,000
67. What is the effective annual interest rate on a 9% annual percentage rate automobile loan that has
monthly payments?
A. 9% C. 9.81%
B. 9.38% D. 10.94%
68. JINX INC. can issue 3-month commercial paper with a face value of P1,000,000 for P980,000.
Transaction costs will be P1,200. The effective annualized percentage cost of the financing, based on
a 360-day year, will be
A. 2.00%. C. 8.48%.

B. 8.00%. D. 8.66%.
69. KAI’SA INC. finances all of its seasonal inventory needs from the local bank at an effective interest
cost of 9%. The firm’s supplier promises to extend trade credit on terms that will match the 9% bank
credit rate. What terms would the supplier have to offer (approximately)?
A. 2/10, n/60. C. 2/10, n/100.
B. 2/10, n/90. D. 3/10, n/60.
70. A company has accounts payable of P5 million with terms of 2% discount within 15 days, net 30 days
(2/15 net 30). It can borrow funds from a bank at an annual rate of 12%, or it can wait until the 30th
day when it will receive revenues to cover the payment. If it borrows funds on the last day of the
discount period in order to obtain the discount, its total cost will be
A. P24,500 more. C. P75,500 less.
B. P51,000 less. D. P100,000 less.
71. Every 15 days a company receives P10,000 worth of raw materials from its suppliers. The credit
terms for these purchases are 2/10, net 30, and payment is made on the 30th day after each
delivery. Thus, the company is considering a 1-year bank loan for P9,800 (98% of the invoice
amount). If the effective annual interest rate on this loan is 12%, what will be the net dollar savings
over the year by borrowing and then taking the discount on the materials?
A. P1,176 C. P3,624
B. P1,224 D. P4,800
72. Three suppliers of KALISTA CORP. offer different credit term. KARMA CO. offers term of 1 1/2/15, net
30. KARTHUS CORP. offers terms of 1/10, net 30. KASSADIN INC. offers of 2/10, net 60. KALISTA
would have to borrow at a bank at an annual rate of 12% in order to take any cash discounts. Which
one of the following would be the most attractive for KALISTA CORP.? (Assume 360 days in a year)
A. Purchase from KARTHUS CORP. and pay in 30 days.
B. Purchase from KARMA CO., pay in 15 days and borrow any money needed from the bank.
C. Purchase from KARMA CO., pay in 30 days and borrow any money needed from the bank.
D. Purchase from KASSADIN INC., pay in 60 days and borrow any money needed from the bank.
73. A company obtained a short-term bank loan of P500,000 at an annual interest rate of 8%. As a
condition of the loan, the company is required to maintain a compensating balance of P100,000 in its
checking account. The checking account earns interest at an annual rate of 3%. Ordinarily, the
company maintains a balance of P50,000 in its account for transaction purposes. What is the effective
interest rate of the loan?
A. 7.77% C. 9.44%
B. 8.50% D. 8.56%
74. KATARINA INC. has developed plans for new pump that will allow more economical operation of the
company’s oil 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, KATARINA
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 KATARINA use? (Use the approximate cost of trade credit.)
A. 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
75. 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.
What is the effective interest rate if the loan is a discount loan with a 10 percent compensating
balance?
A. 17.65% C. 17.50%
B. 20.00% D. 26.50%
- END OF HANDOUTS -


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LOA :TOPIC 02_WORKING CAPITAL MANAGEMENT AY 2021-2022

COLLEGE OF BUSINESS AND ACCOUNTANCY

TOPIC 02 – WORKING CAPITAL MANAGEMENT

Management Advisory Services by Karim G. Abitago, CPA Page 1 of 27

ADDITIONAL FUNDING NEEDED OR EXTERNAL FINANCING NEEDED

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THE CONCEPT OF FLOAT

Total costs of cash balance = Holding costs + Transaction costs

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ACCOUNT RECEIVABLE MANAGEMENT

Total costs of inventories = Ordering costs + Carrying costs

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ACCOUNTS RECEIVABLE MANAGEMENT

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SHORT-TERM BANK LOAN

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5. Which of the following statements is true?

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34. An example of secured short-term financing is:

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QUIZZER (DO-IT-YOURSELF DRILL)

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Debt (Total Asset x 50%) 80,000 100,000

Earnings Before Interest and Tax 36,000 36,000

ROE (Net Income/Equity) 21% 15.6%

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Insurance per unit 0.10

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