WORKING CAPITAL MANAGEMENT

Question 1

1. The goal of working capital management is to:
   C a. Pay off short-term debts
   b. Balance current assets against current liabilities
   c. Achieve a balance between risk and return to maximize the firm’s value
   d. Achieve a balance between short-term and long-term assets to achieve the firm’s overall goals

Answer 1

c. Achieve a balance between risk and return to maximize the firm’s value

Question 2

2. 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 (where: CA = current assets)
   a. Temporary CA with long-term debts
   b. Fluctuating CA with short-term debts
   c. Permanent CA with long-term debts
   d. Permanent CA with short-term debts

Question 3

3. If a firm increases its current assets relative to total assets,
   a. It reduces return and risk
   b. It increases return and risk
   c. It increases return but reduces risk
   d. It reduces return but increases risk

Answer 3

a. It reduces return and risk

Question 4

4. A consultant recommends that a company hold funds for the following two reasons:
   Reason #1: Cash needs can fluctuate substantially throughout the year
   Reason #2: Opportunities for buying at a discount may appear during the year
   The cash balances used to address the reasons given above are correctly classified as
   Reason # 1-Reason # 2
   a. Speculative balances -Speculative balances
   b. Speculative balances -Precautionary balances
   c. Precautionary balances -Speculative balances
   d. Precautionary balances -Precautionary balances

Question 5

5. Which money market security is most often held as a substitute for cash?
   a. Treasury bills
   b. Common stock
   c. Gold
   d. AAA corporate bonds

Answer 5

a. Treasury bills

Question 6

6. Which of the following is true about a firm’s float?
   a. A firm strives to minimize the float for both cash receipts and cash disbursements
   b. A firm strives to maximize the float for both cash receipts and cash disbursements
   c. A firm strives to maximize the float for cash receipts and minimize the float for cash disbursements.
   d. A firm strives to maximize the float for cash disbursements and minimize the float for cash receipts

Question 7

7. A firm has daily cash receipts of P 100,000. A bank has offered to reduce the collection time on the firm’s deposits
   by two days for a monthly fee of P 750. If money market rates are expected to average 6% during the year, what
   is the net annual benefit (loss) from having this service?
   a. P 12,000
   b. P 6,000
   c. P 3,000
   d. P 0

Answer 7

Solution: Benefit: 100,000 (2 days) 6% = 12,000 Cost: 750 (12 months) = 9,000

Question 8

8. A lockbox plan is
   a. Used to identify inventory safety stocks.
   b. A method for safe-keeping of marketable securities.
   c. A system for speeding up a firm’s collections of checks received.
   d. A system for slowing down the collection of checks written by a firm.

Answer 8

c. A system for speeding up a firm’s collections of checks received.

Question 9

9. A growing company is assessing current working capital requirements. An average of 58 days is required to convert
   raw materials into finished goods and to sell them. An average of 32 days is required to collect on receivables. If
   the average time the company takes to pay for its raw materials were 15 days after they are received, then what
   would be the total cash conversion cycle (CCC) for this company?
   a. 11 days
   b. 41 days
   c. 75 days
   d. 90 days

Answer 9

Solution: CCC = (DSI or Age, inventory) + (DSO or Age, AR) – (DPO or Age, AP) = 58 + 32 – 15

Question 10

10. JYP Company has P 5,000,000 of average inventory and sales of P 30,000,000. Using a 365-day year, calculate the firm’s inventory conversion period or age in inventory.
    a. 30.25 days
    b. 45.00 days
    c. 60.83 days
    d. 72.44 days

Answer 10

Solution: Inventory turnover: 30 M ÷ 5 M = 6 times Age of inventory: 365 ÷ 6

Question 11

11. An increase in sales resulting from an increased cash discount for prompt payment would be expected to cause:
    a. A decrease in cash conversion cycle
    b. A decrease in purchase discounts taken c. An increase in operating cycle
    d. An increase in average collection period

Question 12

12. Ignoring cost and other effects, which of the following measures would tend to reduce the cash conversion cycle?
    a. Take cash discounts when offered
    b. Maintain the level of receivable as sales decrease
    c. Forgo cash discounts that are currently being taken
    d. Buy more materials to take advantage of price breaks

Answer 12

c. Forgo cash discounts that are currently being taken

Question 13

13. EOQ is the order quantity that results in
    a. No inventory shortages
    b. Maximum inventory costs
    c. The minimum total annual inventory costs
    d. The maximum total annual inventory costs

Question 14

14. A decrease in inventory order costs will tend to
    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

Answer 14

b. Decrease the economic order quantity

Question 15

15. 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 anticipated demand during the lead time
    c. The square root of the anticipated demand during the lead time
    d. The EOQ multiplied by the anticipated demand during the lead time

Answer 15

b. The anticipated demand during the lead time

Question 16

16. Nayeon Corporation’s economic order quantity (EOQ) for Material MR-69 is 5,000 pounds. If the company maintains a safety stock of MR-69 at 500 pounds, and its order point is 1,500 pounds, what would be the total annual carrying
    costs assuming the carrying cost per unit is P 0.20?
    a. P 100
    b. P 600
    c. P 1,000
    d. P 1,100

Answer 16

Solution: Average inventory: (EOQ/2) + safety stock = (5,000/2) + 500 = 3,000 units Carrying cost: 3,000 (0.2)

Question 16

17. Twice Company uses 4,500 units of Part Once-18 each year. The cost of placing one order for the part is estimated to be about P 20. Other costs associated with carrying Part Once-18 in inventory are:
    Annual cost per part
    Insurance P 0.20
    Property taxes 0.09
    Interest on funds invested 0.15
    Others 0.06
    Total costs P 0.50
    Assume that the company has been able to reduce the cost of placing an order to only P 1.00 and that when the waste and inefficiency caused by inventories is considered, the cost to carry an inventory jumps to P 1.60 per unit.
    What would be the Economic Order Quantity (EOQ) under these conditions?
    a. 75
    b. 80
    c. 95
    d. 100

Answer 16

Solution: EOQ = Square root of [2 D O ÷ C] = Square root of [2 (4,500) 1 ÷ 1.60]

Question 17

18. When a company analyzes credit applicants and increase the quality of accounts rejected, a company is trying to: a. Maximize sales
    b. Maximize profit
    c. Increase bad debt losses
    d. Increase average collection period

Answer 17

b. Maximize profit

Question 18

19. Sana Company’s budgeted sales for the coming year are P 40,500,000 of which, 80% are expected to be credit sales
    at terms of n/30. Sana estimates that a proposed relaxation of credit standards would increase credit sales by 20%
    and increase in the average collection period from 30 days to 40 days. Cost of money is 15%. Based on a 360-day
    year, how much opportunity cost is involved with the proposed relaxation of credit standards?
    a. P 243,000
    b. P 540,000
    c. P 900,000
    d. P 1,620,000

Answer 18

a. P 243,000
Solution: Old AR balance: 32.4 M x (30 ÷ 360) = 2.7 M
Opportunity Cost: 15% (4.32 M – 2.7 M)
New AR balance: 32.4 M x 1.2 x (40 ÷ 360) = 4.32 M

Question 19

20. Momo Company buys on terms 2/10, net 30 but generally does not pay until 40 days after the invoice date. Its purchases total P2,160,000 per year. Assuming 360 days a year, what is the amount of non-free trade credit used by the company on the average each year?
    a. P 240,000
    b. P 180,000
    c. P 120,000
    d. P 60,000

Answer 19

Solution: (2,160,000 ÷ 360) x (40 – 10)
NOTE: FREE trade credit refers to payments made within the discount period while NON-FREE trade credit refers to payment made after the discount period, thereby foregoing discounts or incurring financing costs (hence, non-free).

Question 20

21. If a firm purchases raw material from its supplier on a 2/10, net 60 cash discount basis, the equivalent annual interest rate (using a 360 day-year) of foregoing the cash discount and making payment on the 60th day is
    a. 73.5%
    b. 14.7%
    c. 12.2%
    d. 2.0%

Answer 20

b. 14.7%
Solution: [discount % ÷ (100% - discount %)] x [360 ÷ (credit term – discount term)] = (2 ÷ 98) x (360 ÷ 50)

Question 21

22. An entity obtaining short-term financing with trade credit will pay a higher percentage financing cost when the
    a. Discount percentage is lower
    b. Items purchased have a higher price
    c. Items purchased have a lower price
    d. Supplier offers a longer discount period

Answer 21

d. Supplier offers a longer discount period

Question 22

23. Short-term, unsecured promissory notes issued by large firms are known as:
    a. Commercial paper
    b. Agency securities
    c. Bankers’ acceptances
    d. Repurchase agreements

Answer 22

a. Commercial paper

Question 23

24. Chaeyong Traders borrowed P 30,000 at an annual percentage rate (APR) of 10%. The loan called for a
    compensating balance of 20%. What is the effective interest rate (EAR) on the loan?
    a. 12.5%
    b. 11.1%
    c. 10%
    d. 9.1%

Answer 23

Solution: EAR = 10% ÷ (100% - 20%) Alternatively: EAR = 10% (30,000) ÷ 30,000 (80%) = 3,000 ÷ 24,000

Question 24

25. A company obtained a short-term bank loan of P 250,000 at an APR of 6%. As a condition of the loan, the company
    is required to maintain a balance of P 25,000 in its checking account, which earns 2%. What is the effective interest
    rate of the loan?
    a. 6.66%
    b. 6.44%
    c. 6.00%
    d. 5.80%

Answer 24

Solution: EAR = 6% (250,000) – 2% (25,000) ÷ (250,0000 – 25,000) = 14,500 ÷ 225,000

Question 25

26. A short-term bank loan will have a higher effective financing cost if it has which combination of characteristics?
    a. A 10% compensating balance and regular interest
    b. A 10% compensating balance and discount interest
    c. A 20% compensating balance and regular interest
    d. A 20% compensating balance and discount interest

Question 26

27. Tzuyu Company has a P 2,000,000 line of credit. The line has an interest rate of 6% and a commitment fee of 2%.
    If Tzuyu is using P 400,000 of the line of credit, what is the annual percentage rate (APR) of line of credit?
    a. 6%
    b. 8%
    c. 14%
    d. 16%

Answer 26

Solution: Interest charges: 6% (400,000) = 24,000 Commitment Fee: 2% (2M – 400,000) = 32,000
APR = (24,000 + 32,000) ÷ 400,000