Module 11

THEORIES:

B. WORKING CAPITAL MANAGEMENT

1. Working capital management involves investment and financing

decisions related to:
A. plant and equipment and current liabilities.
B. current assets and capital structure.
C. current assets and current liabilities.
D. sales and credit.

2. As a company becomes more conservative with respect to working capital policy,

it would tend to have a (an)
A. Increase in the ratio of current liabilities to non current liabilities
B. Increase in the operating cycle.
C. Decrease in the operating cycle.
D. Increase in the ratio of current assets to current liabilities.

3. Short-term financing plans with high liquidity have:

A. high return and high risk
B. moderate return and moderate risk
C. low profit and low risk
D. none of the above

4. Temporary working capital supports

A. the cash needs of the company.
B. payment of long term debt.
C. acquisition of capital equipment.
D. seasonal peaks.

5. Zap Company follows an aggressive financing policy in its working capital

Management while Zing Corporation follows a conservative financing policy.
Which one of the following statements is correct?
A. Zap has low ratio of short-term debt to total debt while Zing has a high ratio
of short-term debt to total debt.
B. Zap has a low current ratio while Zing has a high current ratio.
C. Zap has less liquidity risk while Zing has more liquidity risk.
D. Zap finances short-term assets with long-term debt while Zing
finances short-term assets with short-term debt.

6. Which of the following would increase risk?

A. Raise the level of working capital.
B. Decrease the amount of inventory by formulating an effective
inventory policy.
C. Increase the amount of short-term borrowing.
D. Increase the amount of equity financing.

7. The transaction motive for holding cash is for:

A. a safety cushion
B. daily operating requirements
C. compensating balance requirements
D. none of the above
8. The difference between the cash balance on the firms books and the balance
shown on the blank statement is called.
A. the compensating balance.
B. float
C. a safety cushion
D. none of the above

9. The length of time between payment for inventory and the collection of cash is
referred to as:
A. payables deferral period
B. receivables conversion period
C. operating cycle
D. cash conversion cycle

10. As a firm's cash conversion cycle increases, the firm:

A. becomes less profitable
B. increases its investment in working capital
C. reduces its accounts payable period
D. incurs more shortage costs

11. The longer the firm's accounts payable period, the:

A. longer the firm's cash conversion cycle is.
B. shorter the firm's inventory period is.
C. more the delay in the accounts receivable period.
D. less the firm must invest in working capital.

12. The average length of time a peso is tied up in current asset is called the:
A. net working capital.
B. inventory7 conversion period.
C. receivables conversion period.
D. cash conversion period.

13. All of these factors are used in credit policy administration except:
A. credit standards
B. terms of trade
C. peso amount of receivables
D. collection policy

14. Which of the following statements is most correct? If a company lowers its DSO,
but no changes occur in sales or operating costs then:
A. the company might well end up with a higher debt ratio.
B. the company might well end up with a lower debt ratio.
C. the company would probably end up with a higher ROI
D. the company's total asset turnover ratio would probably decline.

15. All but which of the following is considered in determining credit policy?
A. Credit standards
B. Credit limits
C. Accounts payable deferral period
D. Collection efforts
16. The use of safety stock by a firm will:
A. reduce inventory7 costs
B. increase inventory costs
C. have no effect on inventory7 costs
D. none of the above

17. The goal of managing working capital, such as inventory, should be to minimize
the:
A. costs of carrying inventory
B. opportunity cost of capital
C. aggregate of carrying and shortage costs
D. amount of spoilage or pilferage

18. When a specified level of safety stock is carried for an item in inventory, the
average inventory level for that item
A. decreases by the amount of the safety stock.
B. is one-half the level of the safety stock.
C. Increases by one-half the amount of the safety stock.
D. Increases by the number of units of the safety stock.

19. Which of the following statements is correct for a firm that currently has total
costs of carrying and ordering inventory that are 50% higher than total carrying
costs?
A. Current order size is greater than optimal
B. Current order size is less than optimal
C. Per unit carrying costs are too high
D. The optimal order size is currently being used

20. With credit terms of 3/8, n/30, what is the customer's n decision date?
A. Three days after the invoice is received.
B. The 8th day is the customer's decision date.
C. Anytime during the period, 8th to the 30th.
D. The 30th day is the primary decision date.

PROBLEMS:

1. Luke Company has an inventory conversion period of 60 days a receivables

conversion period of 45 days, and a payments cycle of 30 days. What is the
length of the firm's cash conversion cycle?
A. 90 days
B. 75 days
C. 54 days
D. 105 days

2. The Spades Company has an inventory conversion period of 75 days, a

receivables conversion period of 38 days, and a payable payment period of 30
days. What is the length of the firm's cash conversion cycle?
A. 83 days
B. 113 days
C. 67 days
D. 45 days
3. Samaritan Supplies, Inc. has P5 million in inventory and P2 million in accounts
receivable. Its average daily sales are P100,000. The company has PI.5 million in
accounts payable. Its average daily purchases are P50,000. What is the length of
the company's inventory conversion period?
A. 50 days
B. 90 days
C. 120 days
D. 40 days

4. Samaritan Supplies, Inc. has P5 million in inventory and P2 million in accounts

receivable. Its average daily sales are P100,000. The company has P1,5million in
accounts payable. Its average daily purchases are P50,000. What is the length of
the company's cash conversion period?
A. 50 days.
B. 20 days
C. 30 days
D. 40 days

5. Simile Inc. has a total annual cash requirement of P9,075,000 which are to be
paid uniformly. Simile has the opportunity invest the money at 24% per annum.
The company spends, the average, P40 for every cash conversion to marketable
securities.
What is the optimal cash conversion size?
A. P60,000
B. P55,000
C. P45,000
D. P72,500

6. Hyperbole Corporation estimates its total annual cash disbursements of

P3,251,250 which are to be paid uniformly. Hyperbole has the opportunity to
invest the money at 9% per annum. The company spends, on the average, P25
for every cash conversion to marketable securities and vice versa.

What is the opportunity cost of keeping cash in the bank account?

A. P3,825.00
B. P1,912.50
C. P4,190.00
D. P 188.55

7. The Camp Company has an inventory conversion period of 60 days, a receivable

conversion period of 30 days, and a payable payment period of 45 days. The
Camp's variable cost ratio is 60 percent and annual fixed costs of P600,000. The
current cost capital for Camp is 12%.
If Camp's annual sales are P3,375,000 and all sales are on credit, what is the
firm's carrying cost on accounts using 360 days year?
A. P281, 250
B. P168, 750
C. P 20, 250
D. P 56, 250
8. What is the inventory period for a firm with an annual cost of goods sold of P8
million, P1.5 million in average inventory, and a cash conversion cycle of 75
days?
A. 6.56 days
B. 18.75 days
C. 52.60 days
D. 67.50 days

9. What are the expected annual savings from a lock-box system that collects 150
checks per day averaging P500 each, and reduces mailing and processing times
by 2.5 and 1.5 days respectively, if the annual interest rate is 7%?
A. P 5,250
B. P 13,125
C. P 21,000
D. P300,000
10. Casie Company turns out 200 calculators a day at a cost of P250 per calculator
for materials and variable conversion cost. It takes the firm 18 days to convert
raw materials into calculator. Casie's usual credit terms extended to its
customers is 30 days, and the firm generally pays its suppliers in 20 days

If the foregoing cycles are constant, what amount of working capital must Casie
Company finance?
A. P1,400,000
B. P2,400,000
C. P 900,000
D. P1,800,000

11. Caja Companv sells on terms 3/10, net 30. Total sales for the year are P900,000.
Forty percent of the customers pay on the tenth day and take discounts; the
other 60 percent pay, on average, 45 days after their purchases. What is the
average amount of receivables?
A. P70, 000
B. P77, 500
C. P77, 200
D. P67, 500

Question Nos. 12 through 14 are based on the following data:

Sonata Company is considering changing its credit terms from 2/15 net 30 to 3/10,
net 30 in order to speed collections. At present, 40 percent of Sonata Company's
customers take the 2 percent discount. Under the new term, discount customers are
expected to rise to 50 percent. Regardless of the credit terms, half of the customers
who do not take the discount are expected to pay on time, whereas the remainder
will pay 10 days late. The change does not involve a relaxation of credit standards;
therefore bad debt losses are not expected to rise above their present 2 percent
level. However, the more generous cash discount terms are expected to increase
sales from P2 million to P2.6 million per year. Sonata Company's variable cost ratio
is 75 percent, the interest rate on funds invested in accounts receivable is 9 percent,
and the firm's income tax rate is 40 percent.

12. What are the days sales outstanding (DSO) before and after the change of credit
policy?
A. 27.0 days and 22.5 days, respectively
B. 22.5 days and 27.0 days, respectively
 C. 22.5 days and 21.5 days, respectively
D. 21.5 days and 22.5 days respectively

13. The incremental carrying cost on receivable is

A. P 843.75
B. P8, 889.00
C. P 643.75
D. P 6,667.00

14. The incremental after tax profit from the change in credit terms is
A. P68, 493
B. P65, 650
C. P60, 615
D. P57, 615

15. Currently, La Carlota Company has annual sales of P2,500,000.Its average

collection period is 45 days, and bad debts are 3 percent of sales. The credit and
collection manager is considering instituting a stricter collection policy, whereby
bad debts would be reduced to 1.5 percent of total sales, and the average
collection period would fall to 30 days. However, sales would also fall by an
estimated P300,000 annually. Variable costs are 75 percent of sales and the cost
of carrying receivables is 10 percent. Assume a tax rate of 40 percent and 360
days per year.

What would be the decrease in investment in receivables if the change were

made?
A. P 9,688
B. P 12,988
C. P 96,875
D. P129,975
[

16. Palm Company's budgeted sales for the coming year are P40,500,000 of which
80% are expected to be credit sales at terms of n/30. Palm estimates that a
proposed relaxation of credit standards will increase credit sales by 20% and
increase the average collection period from 30 days to 40 days. Based on a 360-
day year, the proposed relaxation of credit to standards result in an expected
increase in the average accounts receivable balance of
A. P 540,000
B. P 900,000
C. P2,700,000
D. P1,620,000

17. What is the economic order quantity for the following in policy: A firm sells
32,000 bags of premium sugar per year. The cost per order is P200 and the firm
experiences a carrying P0.80 per bag.
A. 2,000 bags
B. 4,000 bags
C. 8,000 bags
D. 16,000 bags
18. Marsman Co. has determined the following for a given year:
Economic order quantity (standard order size) 5,000 units
Total cost to place purchase orders for the year P40,000
Cost to place one purchase order P 100
 Cost to carry one unit for one year P 4

What is Marsman's estimated annual usage in units?

A. 1,000,000
B. 2,000,000
C. 500,000
D. 1,500,000

19. BIBO Company is a distributor of videotapes. Pirate Mart is a local retail outlet
which sells blank and recorded videos. Pirate Mart purchases tapes from BIBO
Company at P300.00 per tape; tapes are shipped in packages of 20. BIBO
Company pays all incoming freight, and Pirate Mart does not inspect the tapes
due to BIBO Company's reputation for high quality. Annual demand is 104,000
tapes at a rate of 4,000 tapes per week. Pirate Mart 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 P80
Carrying costs per package per year 3
Relevant insurance, materials handling,
breakage, etc., per year 2
What is the required annual return on investment per package?
A. P6.000
B. P 250
C. P1,200
D. P 600
20. For Raw Material LI2, a company maintains a safety stock of 5,000 pounds. Its
average inventory (taking into account the safety stock) is 12,000 pounds. What
is the apparent order quantity?
A. 18,000 lbs.
B. 6,000 lbs.
C. 14,000 lbs.
D. 24,000 lbs

21. Each stockout of a product sold by Amis Co. costs P1,750 per occurrence. The
company's carrying cost per unit of inventory is P5 per year, and the company
orders 1,500 units of product 20 times a year at a cost of P100 per order. The
probabilities of a stockout at various levels of safety stock are:

Units of Safety Stock Probability of Stockout

0 0.50
100 0.30
200 0.14
300 0.05
400 0.01

The optimal safety stock level for the company based on the units of safety stock
level above is
A. 200 units
B. 300 units
 C. 100 units
D. 400 units

22. Paeng Company uses the EOQ model for inventory control. The company has an
annual demand of 50,000 units for part 6702 and has computed an optimal lot
size of 6,250 unit carrying costs and stock out costs are P9 respectively. The
following data have been gathered in and to determine an appropriate safety
stock level:

Units Short Because of Excess Number of Times Short

Demand during the Lead in the last 40 Reorder
Time Period Cycles
100 8
200 10
300 14
400 8

What is the optimal safety stock level?

A. 100 units
B. 300 units
C. 200 units
D. 400 units

23. Durable Furniture Company uses about 200,000 yards of a particular fabric
each year. The fabric costs P25 per yard. The current policy is to order the fabric
four times a year. Incremental ordering costs are about P200 per order, and
incremental carrying costs are about P0.75 per yard, much of which represents
the opportunity cost of the funds tied up in inventory.

How much total annual costs are associated with the current inventory policy?
A. P19.550
B. P18,750
C. P38,300
D. P62.500

24. Narra Company is considering a switch to level production. Cost efficiencies will
occur under level production and after tax cost would decline by P70,000 but
inventory would increase from P1,000,000 to Pl,800,000. Narra would have to
finance the extra inventory at a cost of 10.5 percent.

What is the maximum interest rate that makes level production feasible?
A. 7.00 percent
B. 5.83 percent
C. 8.75 percent
D. 10.00 percent

25. If a firm is given a trade credit terms of 2/10, net 30, then the cost to the firm
failing to take the discount is:
A. 2.0%.
B. 30.0%.
C. 36.7%
D. 10.0%.
26. The cost of discounts missed on credit terms of 2/ 10, n/60 is
A. 2.0 percent
B. 14.9 percent
C. 12.4 percent
D. 21.2 percent

27. An invoice of a P1OO.OOO purchase has credit terms of 1/10, n/40. A bank loan
for 8 percent can be arranged at any time. When should the customer pay the
invoice?
A. Pay on the 1st.
B. Pay on the 10th
C. Pay on the 40th
D. Pay on the 60th

28. 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 peso savings over the year
by borrowing and the discount on the materials?
A. P3,624
B. P1,176
C. P4,800
D. P1,224

29. 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 borrow funds on the last day of the discount period in
order to obtain the discount, its total cost will be
A. P 51,000 less
B. P100,0001ess
C. P 75,500 less
D. P 24,500 more

30. Diesel Fashion estimates that 90,000 zippers will be needed in the manufacture
of high selling products for the coming year. Its supplier quoted a price of P25
per zipper. Diesel planned to purchase 7,500 units per month but its supplier
could not guarantee this delivery schedule. In order to ensure availability of these
zippers, Diesel is considering the purchase of all these 90,000 units on January 1.
Assuming Diesel can invest cash at 12%, the company's opportunity cost of
purchasing the 90,000 units at the beginning of the year is
A. P127,500
B. P135,000
C. P123,750
D. 264,000

31. You plan to borrow P10,000 from your bank, which offers to lend you the money
at a 10 percent nominal, or stated, rate on a one year loan. What is the effective
interest rate if the loan discount loan?
A. 10%
B. 11.11%
C. 12.45%
 D. 14.56%

32. Perlas Company borrowed from a bank an amount of P1,000,000. The bank
charged a 12% stated rate in an add-on arrangement, payable in 12 equal
monthly installments.
A. 22.15%
B. 24.00%
C. 25.05%
D. 12.70%

33. What is the effective rate of a 15% discounted loan for 90 days, P200,000, with
10% compensating balance? Assume 360 days per year.
A. 20.0%
B. 15.0%
C. 17.4%
D. 22.2%

34. The Premiere Company obtained a short-term bank loan for P1,000,000 at an
annual interest rate 12%. As a condition of the loan, Premiere is required to
maintain compensating balance of P300,000 in its checking account. The
checking account earns interest at an annual rate of 3%. Premiere would
otherwise maintain only P100,000 in its checking account for transactional
purposes. Premiere's effective interest costs of the loan is
A. 12.00%
B. 14.25%
C. 16.30%
D. 15.86%

35. The Peninsula Commercial Bank and Island Corporation to the following loan
proposal:

Stated interest rate of 10% on a one-year discounted 1 and

15% of the loan as compensating balance on zero-interest current account
to be maintained by Island Corporation with Peninsula Commercial Bank.

The loan requires a net proceeds of P1.5 million. What principal amount of loan
applied for as part of the agreement?
A. P1,666,667
B. P2,000,000
C. P1,764,706
D. P1,125,000

C. VALUATION, COST OF CAPITAL AND RISKS

THEORIES:

1. A high price earnings ratio usually indicates that a firm is a:

A. value stock
B. growth stock
C. convertible security
D. constant security

2. If a bond's value rises above its par value during its life, interest rates have:
 A. gone up.
B. gone down.
C. stayed the same
D. there is no correlation with interest rates

3. What will be the price of a bond in which the YTM is higher than the coupon rate?
A. Below face value
B. Above face value
C. At face value
D. Cannot be determined

4. Which of the following statements is correct?

A. Bond prices and interest rates move in the same direction, i.e., if interest rate
rise, so will bond prices.
B. The market price of a discount bond will approach the bond par value as the
maturity date approaches. Barring change in the probability of default, the
value of the bond cannot fail to increase each year as the time to maturity
approaches.
C. The "current yield" on a non cancelable discount bond normally exceed the
bond's yield to maturity.
D. The "current yield" on a non cancelable discount bond normally exceed the
bonds coupon interest rate.

5. The price of a stock is:

A. the future value of all expected future dividends, discounted at the dividend
growth rate.
B. the present value of all expected future dividends, discounted at the dividend
growth rate.
C. the future value of all expected future dividends, discounted at the investor's
required return.
D. the present value of all expected future dividends, discounted at the investor's
required return.

6. What happens when a bond's expected cash flows are discounted at a rate lower
than the bond's coupon rate?
A. The price of the bond increases
B. The coupon rate of the bond increases
C. The par value of the bond decreases
D. The coupon payments will be adjusted to the new discount rate.

7. The discount rate that makes the present value of a bond's payments equal to its
price is termed the:
A. rate of return
B. yield to maturity
C. current yield
D. coupon rate

8. The value of the stock:

A. Increases as the dividend growth rate increases
B. Increases as the required rate of return decreases
C. Increases as the required rate of return increases
D. Both A and B
9. The overall cost of financing for the firm is called the:
A. weighted average cost of capital
B. cost of preferred stock
C. retained earnings breakpoint
D. none of the above

10. The overall weighted average cost of capital is used costs for specific sources of
funds because
A. use of the cost for specific sources of capital would investment decisions
inconsistent.
B. a project with the highest return would always be accepted under the specific
cost criteria.
C. investment funded by equity or debt is not relevant t question
D. None of the above.

11. Which of the following is not a component used in calculating the cost of capital?
A. The cost of short-term debt.
B. The cost of long-term debt.
C. The cost of common stock.
D. The cost of retained earnings.

12. Which of the following changes would tend to increase the companys cost of
capital for a traditional firm?
A. Decrease the proportion of equity financing.
B. Increase the market value of the debt.
C. Decrease the proportion of debt financing.
D. Decrease the market value of the equity.

13. The most expensive source of financing for a firm is:

A. debt
B. preferred stock
C. retained earnings
D. new common stock

14. The cost of capital at the retained earnings breakpoint is

A. weighted average cost of capital
B. marginal cost of capital
C. cost of new stock
D. none of the above

15. Which of the following is not associated with the cost of capital concept?
A. Minimum rate of return on new projects.
B. Weighted average of cost of new funds raised.
C. The required rate of return of investors.
D. The historical cost of funds.

16. Which of the following is likely to increase a firm's cost of capital?

A. Increasing the proportion of equity in the firm in the future.
B. Increasing the proportion of debt in the firm in the future.
C. The consideration of a below-average risk project.
D. Expectation of lower inflation in the future.
17. Which of the following are acceptable criteria for determining the weights in the
weighted average cost of capital?
A. Market value of the capital structure and historical costs of financing.
 B. Market value of capital structure and the target mix of debt and equity.
C. Using the after-tax cost of debt and the market value of the capital
structure.
D. Using book values of the capital structure and the prior level of debt and
equity.

18. The dividend growth model, when used, assumes that the total return on a
share of common stock is comprised of a
A. capital gains yield and a dividend growth rate.
B. capital gains growth rate and a dividend growth rate.
C. dividend yield and the expected price next year.
D. dividend yield and a capital gains yield.

19. The capital asset pricing model (CAPM) states that the total return on share of
common stock is comprised of a
A. The expected risk premium on an investment is proportional to its beta.
B. The expected rate of return on an investment is proportional to its beta.
C. The expected rate of return on an investment depend risk-free rate and the
market rate of return.
D. The expected rate of return on an investment is depend the risk-free rate.

20. The drawback of the CAPM is that it:

A. Ignores the return on the market portfolio
B. Requires a single measure of systematic risk
C. Ignores risk-free return
D. Utilizes too many factors

21. Firms generally decide to call their bonds when interest rates-
A. rise
B. drop
C. remain the same
D. there is no relationship between interest rates and the call provision.

22. If an individual stock's beta is higher than 1.0, that stock is:
A. exactly as risky as the market.
B. riskier than the market.
C. less risky than the market.
D. none of the above

23. The component of the risk-adjusted discount rate that is derived from the risk of
Treasury securities is:
A. risk premium
B. cost of capital
C. call premium
D. risk-free rate

24. The component of the risk-adjusted discount rate compensates the investor for
holding risky assets is the
A. risk-free rate
B. cost of capital
C. risk premium
D. none of the above
25. Which of the following is incorrect regarding the measurement and interpretation
of the beta of a security?
A. Not all securities are equally affected by fluctuations in the market.
B. The sensitivity of a stock to market movements is known as alpha.
C. Stocks with a beta greater than 1.0 are particularly sensitive to market
fluctuations. Those with a beta of less than 1.0 are not so sensitive to such
movements
D. The average beta of all stocks is 1.0.

26. If you were willing to bet that the overall stock market was heading up on a
sustained basis, it would be logical to invest in
A. high beta stocks.
B. low beta stocks.
C. stocks with large amounts of unique risk.
D. stocks that plot below the security market line.

27. What will happen to the expected return on a stock with a beta of 1.5 and a
market risk premium of 9% if the Treasury bill yield increases from 3% to 5%?
A. The expected return will remain unchanged.
B. The expected return will increase by 1.0%.
C. The expected return will increase by 2.0%.
D. The expected return will increase by 3.0%.

28. Which one of the following statements is true regarding the beta coefficient?
A. Beta is a measure of unsystematic risk.
B. A beta greater than one represents less systematic risk than the market.
C. Generally speaking, the higher the beta the higher the expected return.
D. A beta of one indicates an asset is totally risk-free.

29. The major benefit of diversification is to:

A. increase the expected return.
B. remove negative risk assets from the portfolio.
C. reduce the portfolio's systematic risk.
D. reduce the expected risk

30. Stocks that have high financial rewards are generally accompanied by:
A. high dividend payments
B. low dividend payments because of internally generated growth
C. high risk
D. All of the above

31. The market risk premium is:

A. The difference between the rate of return on an asset and the risk-free rate.
B. The difference between the rate of return on the market portfolio and the
risk-free rate
C. The risk-free rate.
D. The market rate of return.

32. If a firm uses the same company cost of capital for evaluating all projects, which
of the following is likely?
A. Rejecting good low-risk projects
B. Accepting poor high-risk projects
C. Both A and B
D. Neither A nor B
33. Using the company cost of capital to evaluate a project is:
A. Always correct
B. Always incorrect
C. Correct for projects that are about as risky as the average the firm's other
assets
D. None of the above

34. The company cost of capital may be an inappropriate discount rate for a capital
budgeting proposal if:
A. it calculates a negative NPV for the proposal.
B. the proposal has a different degree of risk.
C. the company has unique risk.
D. the company expects to earn more than the risk-free rate.

35. In calculating the cost of common stock equity, the model having the stronger
theoretical foundation is:
A. the constant growth model.
B. the variable growth model.
C. the Gordon model.
D. the capital asset pricing model.

PROBLEMS:

1. A five-year PI,000 par value bond pays a 6.50% annual Given a YTM of 8.0%,
what is the price of the bond today?
A. P1,040
B. P 860
C. P 940
D. P1,000

2. Paramount Company's stock is expected to generate a dividend and terminal

value one year from now of P57.00, The stock has a beta of 1.3, the risk-free
interest rate is 6 percent, and the expected return market return is 11 percent.
What should the equilibrium price of Investors' stock in the market now?
A. P50.67
B. P43.85
C. P53.77
D. P41.22

3. The Tuck Corporation pays annual dividends of P6.00 on the cumulative

preferred stock. What is the current value of this stock if an investor requires a
10 percent annual rate of return
A. P 60
B. P 6
C. P600
D. P 10

4. What is the current price of a share of stock when last year dividend was P3.00,
the growth rate is 6 percent, and the investor's required rate of return is 12
percent?
A. P25.00
 B. P26.50
C. P50.00
D. P53.00

5. What is the current price of a share of stock when the current dividend is P4.75,
the growth rate is 7%, and the investor's required rate of return is 11%?
A. P 18. 75
B. P43.16
C. P 46.2.0
D. P127.06

6. You are planning to invest in common stock of Eagle, Inc. Lately, the firm paid a
dividend of P7.80. You have projected that dividends will grow at a rate of
9.0% per year indefinitely. If you want an annual return of 24.0%, what is the
most you should pay for the stock now?
A. P52.00
B. P56.68
C. P32.50
D. P35.43

7. Dangling, Inc. is a firm that is experiencing rapid growth. Lately, the firm paid a
dividend of P5.90. You believe that dividends will grow at a rate of 19.0% per
year for three years, and then at a rate of 7.0% per year thereafter. If you
expect an annual rate of return of 12.0% on this investment and you plan to
hold the stock indefinitely, what is the most you would pay for the stock now?
A. P155.22
B. P171.45
C. P131.09
D. P185.60

8. OPQ Company is considering buying common shares in Oceanic Company. OPQ

has projected that the next dividend the company will pay will equal P4.00 and
that dividends will grow at a rate of 7.0% per year thereafter. The firm's beta is
1.75, the risk-free rate is 7.5%, and the market return is 11.3%. What is the
most you should pay for the stock now?
A. P30.259.
B. P59.86
C. P55.94
D. P89.12

9. Filam's Company expects to pay a dividend of P6 per share at f end of year one,
P9 per share at the end of year two, and then sold for P136 per share. If the
required rate on the stock is 20/ what is the current value of the stock?
A. P100.10
B. P105.69
C. PI 10.00
D. P120.29

10. Constantly Company is a no growth firm and has 2 million shares outstanding.
It is expected to earn a constant P20 million per year on its assets. If all
earnings are paid out as dividends and the cost of capital is 10%, calculate the
current price per share for the stock.
A. P200
 B. P100
C. P150
D. P 50

11. Lion Company will pay a dividend of PI.50 per share at the end of next 12
months. The required rate of return for Lion's share is 10 percent and the
constant growth rate is 5 percent.

The approximately current market price per common share of Lion stock is
A. P30.00
B. P10.00
C. P15.00
D. P26.63

12. Calculate the dividend payout ratio based on the following values for a listed
company.

Dividend 2.28
P/E 19.00
Close 75.25

A 57.6%
B. 25.3%
C. 12.0%
D. 3.0%

13. The current yield on a bond worth P900 with a par value of PI, 000 and a
coupon rate of 10% is:
A. 10.00%
B. 11.11%
C. 12.05%
D. 9.75%

14. The Lakeview Company's bonds have 4 years remaining to maturity. Interest is
paid annually; the bonds have a P1,000 face value and the coupon interest rate
is 9 percent.

What is the estimated yield to maturity of the bonds at their current market
price of P829?
A. 8.23 percent
B. 13. 10 percent
C. 10.86 percent
D. 14.80 percent

15. What is the expected YTM on a bond that pays a PI 50 coupon annually, has a
P1,000 par value, and matures in six years if the current price of the bond is
P978?
A. 18.9%
B. 36.7%
C. 15.6%
D. 13.9%
16. You are considering the purchase of a bond with a 13% coupon rate paid and
compounded semiannually. The bond will mature in 8 years, and has a P1, 000
face value. The bond currently sells17, for P867. Calculate the annual yield to
maturity for this bond (Round to nearest percentage.)
A. 8 percent
B. 9 percent
C. 13 percent
D. 16 percent

17. What is the yield to maturity (APR) of a bond with the following characteristics?

Coupon rate: 8% with semi-annual payments

Current price: P960
Maturity: three years until maturity.

A. 4.78%
B. 5.48%
C. 9.57%
D. 12.17%

18. What is the rate of return for an investor who pays P1,054.47 for a three-year
bond with a 7% coupon and sells the bond one year later for P1,037.19?
A. 5.00%
B. 5.33%
C. 6.46%
D. 7.00%

19. Heidi Company plans to issue some PI00 preferred stock v an 11 percent
dividend. The stock is selling on the market P97, and Heidi must pay flotation
costs of 5 percent of market price. The company is under the 40 percent
corporate tax rate. The cost of preferred stock for Heidi Company is
A. 7.16 percent
B. 11.34 percent
C. 6.80 percent
D. 11.94 percent

20. If share of stock provided a 14.0% nominal rate of return over previous year
while the real rate of return was 6.0%, then the inflation rate was:
A. 1.89%
B. 7.55%
C. 8.00%
D. 9.12%

21. Milky Way, Inc. paid a cash dividend to its common shareholders over the past
twelve months of P2.20 per share. The current market value of the common
stock is P40 per share and investors are anticipating the common dividend to
grow at a rate of 6% per annum. The cost to issue new common stock will be 5
percent of the market value. The expected returns on retained earnings is
A. 12.14 percent
B. 11.83 percent
C. 11.79 percent
D. 14.05 percent
22. What is the estimated required rate of return for equity investors if a stock sells
for P40 and will pay a P4.40 dividend that is expected to grow at a constant
rate of 5%?
A. 7.6%
B. 12.0%
C. 12.6%
D. 16.0%

23. The earnings, dividends, and stock price of Sum Company are expected to grow
at 7 percent per year after this year. Sum Company's common stock sells for
P23 per share, its last dividend was P2.00 and the company pay P2.14 at the
end of the current year. Sum Company should pay P2.50 flotation cost.

Using the dividend growth model, what is the expected cost of retained earnings
for Sum Company?

A. 10.44 percent
B. 16.30 percent
C. 9.30 percent
D. 17.44 percent

24. The Wind Company's last dividend was P3.00; its growth rat 6 percent and the
stock now sells for P36.New stock ca sold to net the firm P32.40 per share.

What is Wind Company's cost of new common stock?

A. 14.83 percent
B. 15.81 percent
C. 15.26 percent
D. 9.69 percent

25. Platon Company's stock is currently selling for P60 a share. The firm is expected
to earn P5.40 per share and to pay a year-end dividend of P3.60.

If investors require a 9 percent return, what rate of growth must be expected

for Platon?
A. Zero growth
B. 3.0 percent
C. 40.0 percent
D. 50.0 percent

26. Okkawa Company's stock is currently selling for P120 as the firm is expected to
earn P10.80 per share and to pay end dividend of P7.20. Investors require a 9
percent return.

If Okkawa Company reinvests retained earnings in projects whose aggregate

return is equal to the stock's expected return, what will be next year's Earnings
per Share?
A. P11.12
B. P10.80
C. P 7.42
D. P11.77
27. Gelo an investor, receives a 15% total return by purchasing a tock for P40 and
selling it after one year with a 10% capital gain. How much was received in
dividend income during the year?
A P2.00
B. P2.20
C. P4.00
D. P6.00

28. Alternate Company's stock currently sells for P45.00 per share. It is expected to
pay a dividend of P3.10 next year, its growth rate is a constant 7.0%, and the
company will incur a flotation cost of 12.0% of the market value if it sells new
common stock. The firm's tax is 40%. What is the firm's cost of retained
earnings?
A. 13.89%
B. 14.37%
C. 15.38%
D. 14.83%

29. If a stock is purchased for P25 per share and held one year, during which time a
P3.50 dividend is paid and the price climbs to P28.25, the nominal rate of
return is:
A. 13.00%
B. 14.00%
C. 23.01%
D. 27.00%

30. Given a stock price of P39.77 and an expected return to share holders of
12.4%, what is the likely growth rate if the annual dividend next year is
expected to be P3.50?
A. 0.0%
B. 3.6%
C. 8.4%
D. 12.4%

31. Dalmatian Co. is currently paying a dividend of P2.20 per share. The dividends
are expected to grow at 25% per year for the next four years and then grow
5% per year thereafter. Calculate the expected dividend in year 6.
A. P5.37
B. P2.95
C. P5.92
D. P8.39

32. According to CAPM estimates, what, is the cost of equity for a firm with beta of
1.5 when the risk-free interest rate is 6% and the expected return on the
market portfolio is 15%?

A. 19.5%
B. 21.0%
C. 22.5%
D. 24.0%
33. The expected return on Globe Oil stock is 18.95%. If the market premium is
8.2% and the risk-free rate is 6.4%, what is the beta of Globe Oil stock?
A. 2.88
B. 1.53
C. 1.30
D. 6.97

34. An investor was expecting a 18% return on his portfolio with beta of 1.25 before
the market risk premium increased from 8% to 10%. Based on this change,
what return will now be expected on the portfolio?
A. 20.0%
B. 20.5%
C. 22.5%
D. 26.0%

35. The expected rate of return of stock of Phoslate Company, give beta of 1.25,
risk free rate of 7.5%, and, a market risk premium 6%, is:
A. 9.0%
B. 13.5%
C. 15.4%
D. 15.0%

36. What is the risk-free rate given a beta of 0.8, a market risk premium of 6%,
and an expected return of 9.8%?
A. 3.2%
B 5.0%
C. 5.2%
D. 6.8%

37. The earnings, dividends, and stock price of Equity, Inc. are expected to grow at
7 percent per year after this year. Equity's common stock sells for P23 per
share, its last dividend was P2.00 and will pay P2.14 at the end of the current
year. Equity should pay P2.50 flotation cost.

If the firm's beta is 1.75, the risk-free rate is 8 percent, and the average return
on the market is 12 percent, what will be the firm's cost of equity using the
CAPM approach?

A. 16.05 percent
B. 15.00 percent
C. 14.27 percent
D. 14.00 percent

38. The following data are related to Samba stock:

Required return on Samba common 15 percent
Beta coefficient 1.5
Risk-free rate 9.0 percent
[
The required market return is
A. 13.0 percent.
B. 18.0 percent
C. 25.0 percent
D. 16.0 percent
39. What is the required rate of return for a security with a Beta of .8 when the
market return is 12 percent, the real rate of return is 3 percent, and the
expected inflation premium is 2 percent?
A. 17.8 percent
B. 8.6 percent
C. 10.6 percent
D. 12.6 percent

40. The beta of debt is 0.4 and beta of equity is 1.2. The debt-equity ratio is 0.8.
Calculate the beta of the assets of the firm. (Assume no taxes.)
A. 0.84
B. 0.48
C. 1.60
D. None of the above

41. What is the asset beta given the debt beta is .2, the equity beta is 1.4, the
market value of equity is P45 million, and the market value of debt is PI 5
million?
A. 0.20
B. 1.10
C. 1.40
D. 1.50

42. The market value of Negros Company's equity is PI5 million, and the market
value of its risk-free debt is P5 million. If the required rate of return on the
equity is 20% and that on the debt is 8%, calculate the company's cost of
capital. (Assume no taxes.)
A. 17%
B. 20%
C. 8.1%
D. None of the above

43. Assume the following information about a firm's capital components:

Capital Structure Cost

Debt P2 M 8%
Preferred stock P2 M 11%
Common stock P6 M 14%

What is the firm's weighted-average cost of capital?

A. 11-00%
B. 11.90%
C. 12.05%
D. 12.20%

44. The company cost of capital for a firm with a 60/40 debt/equity split, 8% cost of
debt, 15% cost of equity, and a 35% tax rate would be:
A. 7.02%
B. 9.12%
C. 10.80%
D. 13.80%
45. The Nut Corporation finds that it is necessary to determine its marginal cost of
capital. Nut's current capital structure calls for 45 percent debt, 15 percent
preferred stock and 40 percent common equity. The costs of the various
sources of financing are as follows: debt, after-tax 5.6 percent; preferred stock,
9 percent; retained earnings, 12 percent; and new common stock, 13.2
percent.

If the firm has P12 million retained earnings, and Nut has an opportunity to
invest in an attractive project that costs P45 million, what is the marginal cost
of capital of Nut Corporation?
A. 8.83 percent
B. 8.91 percent
C. P9.95 percent
D. P12.40 percent
46. A firm has common stock with a market price of P100 per share and an expected
dividend of P5.61 per share at the end of 2007. A new issue of stock is
expected to be sold for P98, with a P2 per share representing the under pricing
necessary in the competitive capital market. Flotation costs are expected to t
P1 per share. The dividends paid on the outstanding stock last 5 years are:

Year Dividend
2002 P4.00
2003 4.28
2004 4.58
2005 4.90
2006 5.24

What is the expected returns on the new issue of common stock in January
2006?
A. 5.8 percent
B. 7.7 percent
C. 10.8 percent
D. 12.8 percent
Question Nos.47 through 53 are based on the following information:

The Solar Laboratories, Inc., a multinational company, is expanding is research and

production capacity to introduce a new line of products Current plans call for the
expenditure of P100 million on four project of equal size (P25 million each), but
different returns. Project A is in blood clotting proteins and has an expected return of
18 percent Project B relates to a hepatitis vaccine and carries a potential return 14
percent. Project C, dealing with a cardiovascular compound, expected to earn 11.8
percent and Project D, an investment orthopedic implants, is expected to show a
10.9 percent return. The firm has PI5 million in retained earnings. After a capital
structure with P15 million in retained earnings is reached (in which ret earnings
represent 60 percent of the financing), all additional financing must come in the form
of new common stock. Common stock is selling for P25 per share and underwriting
cost estimated at P3 if new shares are issued. Dividends for the next year will be P90
per share (D1), and earnings and dividends have grown consistently at 11 percent.
The yield on comparative bonds has been hovering at 11 percent. The investment
banker feels that the first P20 million of bonds could be sold to yield 11 percent while
additional debt might require a 2 percent premium and be sold to yield 13 percent.
The corporate tax rate is 30 percent. Debt represents 40 percent of the capital
structure.

47. The expected returns on common equity are:

Retained Earnings Common Shares

A. 14.6% 15.1%
B. 15.0% 15.5%
C. 15.1% 14.6%
D. 15.5% 15.0%

48. What is the initial weighted average cost of capita?

A. 13.2%
B. 12.1%
C. 11.8%
D. 9.2%

49. At what size of the capital structure would there be a change in the cost of
equity component?
A. PI5 million
B. P20 million
C. P25 million
D. P50 million
50. What is the marginal cost of capital of capital at retained earnings breakpoint?
A. 11.84%
B. 9.42%
C. 12.38%
D. 12.14%

51. At what size of capital structure will there be a change in the cost of debt?
A. P20 million
B. P25 million
C. P50 million
D. P75 million

52. The selection of the project is based on ranking of profitability. What is the
marginal cost of capital. What is the expected marginal cost of capital of
financing Project C?
A. 12.9%
B. 12.4%
C. 12.7%
D. 10.2%

53. Which of the four project will be accepted by the company?

A. Project A only.
B. Project A and B only
C. Project A, B, and C
D. All of them.

D. RISK AND LEVERAGE

THEORIES:
1. The use of financial leverage by the firm has a potential impact which of the
following?

(1) The risk associated with the firm

(2) The return experienced by the shareholder
(3) The variability of net income
(4) The degree of operating leverage
(5) The degree of financial leverage

A. 1, 3, 5
B. 2, 3, 4, 5
C. 1, 2, 3, 5
D. 1, 2 ,5

2. Which of the following is a key determinant of operating leverage?

A. Level of debt
B. Cost of debt
C. Technology
D. Capital structure
3. The degree of operating leverage for Alabang Company is 3.5, and the degree of
operating leverage for Paranaque Corporation is 7.0. According to this
information, which firm is considered to have greater business risk?
A. Alabang Company.
B. Paranaque Corporation.
C. The degree of operating leverage is not a measure of business risk, so it is
not possible to tell which firm has the greater business risk given the above
information.
D. To determine which firm has the greater business risk, we need to know the
operating income (NOI or EBIT) of each firm Paranaque Corporation would
have less business risk operating income is at least twice that of Alabang
Company

4. It refers to management strategy of financing assets with borrowed capital;

such an extensive use raise the entity risk thereby impacting on the return on
common stockholders' equity to be above or below the rate of return on total
assets.
A. Factoring
B. Leverage.
C. Mortgage.
D. Restructuring

5. A decrease in the debt ratio will least likely affect:

A. Financial risk
B. Business risk
C. Systematic or market risk
D. Total risk
6. Which of the following changes would tend to increase the company cost of
capital for a traditional firm?
A. Decrease the proportion of equity financing.
B. Increase the market value of the debt.
C. Decrease the proportion of debt financing.
D. Decrease the market value of the equity.
[

7. When establishing their optimal capital structure, firms should strive to:
A. minimize the weighted average cost of capital
B. minimize the amount of debt financing used
C. maximize the marginal cost of capital
D. none of the above
8. Although debt financing is usually the cheapest component of capital, it cannot
be used to excess because
A. interest rates may change.
B. the firm's stock price will increase and raise the cost of equity financing
C. the financial risk of the firm may increase and thus drive up the cost of all
sources of financing
D. none of the above.

9. Which of the following is incorrect regarding operating leverage?

A. Operating leverage is the degree to which costs are fixed
B. A project's break-even point will be affected by the extent to which costs
can be reduced as sales decline.
C. If the project has mostly variable costs, it is said to have high operating
leverage.
D. High operating leverage implies that profits are more sensitive to changes in
sales.
10. The mix of debt, preferred stock, and common equity with which the firm plans
to raise capital is called the:
A. financial risk
B. operating leverage
C. business
D. target capital structure

11. The extent to which fixed costs are used in a firm's operations is called its:
A. financial leverage.
B. operating leverage.
C. financial leverage.
D. foreign risk exposure.

12. Financial risk refers to the:

A. risk of owning equity securities
B. risk faced by equity holders when debt is used
C. general business risk of the firm
D. possibility that interest rates will increase
13. The mix of debt and equity that minimizes the cost of capital the:
A. optimal operating leverage
B. target financial structure
C. optimal degree of combined leverage
D. optimal capital structure

14. Which of the following situations is likely to have the highest combined business
and financial risk impact upon a business
A. A new labor-intensive operation is funded with operating cash flows
B. A fully automated plant is completed, funded with retained earnings
C. A fully automated plant is completed, funded with the issuance
of 10-year bonds
 D. An automated, but dated plant in the southern region is closed and
operations are resumed in a labor-intensive plant in Central Luzon

15. The most commonly held view of capital structure is that the weighted average
cost of capital:

A. falls first with moderate levels of leverage and then increases.

B. does not change with leverage.
C. increases proportionately with increases in leverage.
D. increases with moderate amounts of leverage and then falls.

16. The degree of financial leverage for April Company is 3.0, and the degree of
financial leverage for August Corporation is 6.2. According to this information,
which firm is considered to have greater overall (total) risk?
A. April Company.
B. August Corporation.
C. The degree of financial leverage is a measure of financial risk, so the only
conclusion that can be made with the information given is that August
Corporation has greater financial risk than April Company -- we cannot tell
which firm has greater total risk.
D. To determine which firm has the greater total risk, we need to know the
financial breakeven point of each firm.

PROBLEMS:

1. If the pro forma balance sheet shows that total assets increase by P40,.000
while retaining a debt- equity ratio of .75 then
A. debt must increase by P300,000.
B. equity must increase by the full P400,000.
C. debt must increase by P171.428.
D. equity must increase by P100,000,

2. Absolute Corporation has a capital structure that consists of 65/-equity and

35% debt. The company expects to report PI 00 million in net income this year,
and 67.5% of the net income will be paid out as dividends. How large can the
firm's capital budget be this year without it having to include the cost of new
common stock in its; cost of capital analysis?
A. P100.0 million
B. P 67. 5 million
C. P 50.0 million
D. P 32.5 million

3. The Salvage Company projects the following for the upcoming year:
Earnings before interest and taxes P40 million
Interest expense P 5 million
Preferred stock dividends P 4 million
Common stock dividend payout ratio 20%
Average number of common shares 2 million
outstanding
Effective corporate income tax rate 40%

The expected dividend per share of common stock is

A. P1.70
 B. P1.86
C. P2.10
D. P1.00

4. How much will a firm need in cash flow before tax and interest o satisfy debt
holders and equity holders if the tax rate is 40%, there is P10 million in
common stock requiring a 12% return, and P6 million in bonds requiring an 8%
return?
A. P1,392,000
B P1,488,000
C. P2,480,000
D. P2,800,000

5. During the past five years, Pena Company had consistently paid 50% of earnings
available to common as dividends. Next year, the Pena Company projects its
net income, before the P1.2, million preferred dividends, at P6 million

The capital structure for the company is maintained at:

Debt 25.5%
Preferred stock 15.0%
Common equity 60.0%
What is the retained earnings break-point next year?
A. P5, 760,000
B. P4, 800,000
C. P4, 000,000
D. P6, 000,000
6. Balon Company expects P30 million in earnings next year. Its dividend payout.
ratio is 40 percent, and its equity to asset ratio is 40 percent. Balon Company
uses no preferred stock.
At what amount of financing will there be a break point in Salon's cost of
capital?
A. P45 million
B. P20 million
C. P30 million
D. P18 million
7. Alvin Company expects next year's after-tax income to be P7,500,000. The
firm's debt ratio is currently 40 percent. Alvin Company has P6,000,000 of
profitable investment opportunities and it wishes to maintain its existing debt
ratio. According to the residual dividend policy, what is the expected dividend
payout ratio next year?
A. 52.0 percent
B. 75.0 percent
C. 48.0 percent
D. 25.0 percent

8. The Dumaguete Co. has an equity cost of capital of 17%. The debt to equity
ratio is 1.5 and a cost of debt is 11%. What is the weighted average cost of
capital of the firm? (Assume a tax rate of 33%)
A. 3.06%
B. 13.40%
C. 16.97%
 D. 15.52%

9. Calculate the DFL for a firm with EBIT of P6,000,000, fixed cost of P3, 000,000,
interest expense of PI, 000, 000, preferred stock dividends of 800,000, and a
40 percent tax rate.
A. 6.0
B. 9.0
C. 1.43
D. 1.64

10. A firm is expected to generate P1.5 million in operating income and pay
P250,000 in interest. Ignoring taxes, this will generate P12.50 "earnings per
share. What will happen to EPS if operating income increases to P2.0 million?
A. EPS increase to P15.63
B. EPS increase to P16.67
C. EPS increase to P17.50
D. EPS increase to P20.00

11. The board of directors of Aggressive Company was unhappy with the current
return on common equity. Though the return on sales (profit margin) was
impressively, good at 12.5 percent, the asset turnover was only 0/75. The
present debt ratio is 0.40.

Ms. Sylvia Moreno, the vice-president of corporate planning, presented a

proposal as follows:

Profit margin should be raised to 15 percent.

. The new capital structure will be revised by raising debt component.
The asset turnover will be maintained at 0.75.

The proposed adjustment is estimated to raise return on equity by 50 percent.

What debt ratio did Ms. Moreno propose in order to raise the return on equity
(ROE) to 150 percent of the present level?
A. 0.52
B. 0.68
C. 0.61
D. 0.72

12. Ellis Company expects to generate P10 million internally which could be
available for financing part of its P12 million capital budget for this coming
year. Ellis' management believes that a debt-equity ratio of 40 percent is best
for the firm. How much should be paid in dividends if the target debt-equity
ratio is to be maintained?
A. P2,800,000
B. P8,571,429
C. P1,428,571
D. P4,000,000

Use the following information to answer Question Nos. 13 through 18:

The Reliable Corporation, a manufacturer of radar control equipment is planning to

sell its shares to the general public for the first time. The firm's investment banker is
working with the Reliable Corporation in determining a number of items. Information
on the Reliable Corporation follows:

Reliable Corporation
Income Statement
For the Year 2007
Sales (all on credit) P22,428,000
Cost of goods sold 16,228,000
Gross6,200,000
profit
Selling and administrative expenses 2,659,400
Operating profit 3,540,600
Interest expense 370,600
Net income before taxes 3,170,000
Taxes 1,442,00
Net income P 1,728,000

Balance Sheet
As of December 31, 2007
Assets
Cash P 150,000
Marketable securities 100,000
Account receivable 2,000,000
Inventory 3,800,000
Total current assets P 6,050,000
Net plant and equipment 6,750,000
Total assets P12,800,000

Liabilities and Stockholders' Equity

Accounts payable P 1,000,000
Notes payable 1,200,000
Total current liabilities 2,200,000
Long-term liabilities 2,380,000
Total liabilities P 4,580,000
Common stock (1,200,000 shares at P1 par) P 1,200,000
Capital in excess of par 2,800,000
Retained earnings 4,220,000
Total stock holders' equity 8,220,000
Total liabilities and stock holders equity P12,800,000

The new public offering will be at 10 times the earnings per share.

13. Assume that 500,000 new corporate shares will be issued to the general public.
What will earnings per share immediately after the public offering be?
A. P1.02
B. P1.44
C. P1.19
D. P1.59

14. Based on the price-earnings ratio of 10, what will the initial price of the stock
be?
A. P14.40
 B. P11.90
C. P10.20
D. P15.90

15. Assuming an under writing spread of 7 percent and out-of-Pocket costs of

P150,000, what will net proceeds to the corporation be?
A. P4, 743,000
B. P4, 593,000
C. P4, 950,000
D. P5, 307,000

16. What return must the corporation earn on the net proceed equal the earnings
per share before the offering?
A. 16.18%
B. 16.58%
C. 15.68%
D. 15.988%

17. Assume that, of the initial 500,000-share distribution, 250000 shares belong to
current stockholders and 250,000 are new corporate shares, and these will be
added to the 1,200000 corporate shares currently outstanding. What will the
initial market price of the stock be? Assume a price-earnings ratio of 10 and
use earnings per share after the distribution in the calculation.
A. P10.90
B. P11.90
C. P10.20
D. P12.15

18. Assuming an underwriter spread of 7 percent and out-of-pocket costs of

P150,000, what return must the corporation earn on the net proceeds to equal
earnings per share before the offering?
A. 13, 50%
B. 13.76%
C. 15.68%
D. 14.57%

E. QUANTITATIVE METHODS

THEORIES:

1. The economic order quantity is the order quantity that results in

A. the minimum total annual inventory costs.
B. no inventories shortages.
C. the maximum total annual inventory costs.
D. minimum ordering costs.

2. 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. Higher purchase-order cost and lower carrying cost.
B. Higher purchase-order cost and higher carrying cost.
 C. Lower purchase-order cost and higher carrying cost.
D. Lower purchase-order cost and lower carrying cost.

3. A decrease in inventory order costs will

A. Increase the reorder point.
B. Decrease the economic order quantity.
C. Have no effect on the economic order quantity.
D. Decrease the holding cost percentage.

4. An increase in inventory holding costs will

A. Decrease the economic order quantity.
B. Have no effect on the economic order quantity.
C. Increase the economic order quantity.
D. Decrease the number of orders issued per year.

5. Which one of the following statements best describes a difference, between basic
PERT and the Critical Path Method (CPM) of network analysis?
A. PERT uses probability distribution on the activity times while CPM uses point
estimates for the activity times.
B. PERT does not allow for slack times on the activities while CPM does.
C. PERT considers only activity cost while CPM considers only activity time.
D. PERT determines the least-cost path through a network while CPM
determines the least-time path through a network.

6. Critical Path Method (CPM) is a technique for analyzing, planning, and scheduling
large, complex projects by determining the critical path from a single time
estimate for each event in a project. The critical path:
A. Is the shortest path from the first event to the last event for a project.
B. Is an activity within the path that requires the most number of time.
C. Has completion that reflects the earliest time to complete the project.
D. Is the maximum amount of time an activity may be delayed without
delaying the total project beyond its target completion time.

7. A company is designing a new regional distribution warehouse. To minimize

delays in loading and unloading trucks, an adequate number of loading docks
must be built. The most relevant technique to assist in determining the proper
number docks is
A. Cost-volume-profit analysis
B. PERT/CPM analysis
C. Linear programming
D. Queuing theory

Use the following information to answer question Nos. 8 and 9:

The Kinis Company produces a cosmetic product in 60 gallon batches The basic
ingredients used are material X, costing P70 per gallon, and material Y, costing PI70
per gallon. No more than 18 gallons of X can be used, and at least 15 gallons of Y
must be used.

8. How would the objective function (minimization of product cost) be expressed?

A. 70X+ 170Y
B. 18X + 15Y
 C. 170X + 70Y
D. 18X + 42 Y

9. Which of the following is not a constraint of the Kinis Company?

A. X < 18
B. X + Y < 60
C. Y> 15
D. X> 0

Use the following data to answer Question Nos. 10 through 12:

Sun, Inc. manufactures product X and product Y, which are processed as follows:

Type A machine Type B machine

Product X 6 hours 4 hours
Product Y 9 hours 5 hours

The contribution margin is PI2 for product X and P7 for product. The available time
daily for processing the two products is 120 hoi for machine Type A and 80 hours for
machine Type B.

10. How would the constraint for machine Type A be expressed?

A. 4X + 5Y
B. 6X + 9Y < 120
C. 4X + 5.Y < 80
D. 12X + 7Y

11. How would the constraint for machine Type B be expressed?

A. 4X + 5Y
B. 6X + 9Y < 120
C. 4X + 5Y < 80
D. 12X + 7Y

12. How would the objective function be expressed?

A. 4X + 5Y
B. 6X + 9Y<; 120
C. 4X + 5Y < 80
D. 12X + 7Y

PROBLEMS:

1. Contratista, Inc. is considering a three-phase research project. The time

estimates for completion of Phase 2 of the project are:

Pessimistic 24 weeks
Most likely 20 weeks
Optimistic 10 weeks

Using the program evaluation and review technique (PERT), the expected time
for completion of Phase 2 should be
A. 20 weeks
B. 19 weeks
C. 18 weeks
 D. 24 weeks

2. Castle Building Company uses the critical path method to monitor construction
jobs. The company is currently 2 weeks behind schedule on Job WW, which is
subject to a P10,500-per-week completion penalty. Path A-B-C-F-G-H-I has a
normal completion time of 20 weeks, and critical path A-D-E-F-G-H-I has a
normal completion time of 22 weeks. The following activities can be crashed.

Activities Cost to Crash 1 Week Cost to Crash 2 Weeks

BC P 8,000 P15,000
DE 10,000 19,600
EF 8,800 19,500

Castle desires to reduce the normal completion time of Job V and, at the same
time, report the highest possible income for t year. Castle should crash
A. Activity BC 1 week and activity EF 1 week
B. Activity BC 2 weeks
C. Activity DE 1 week and activity BC 1 week
D. Activity DE 1 week and activity EF 1 week

3. Wind Company expects an 85% learning curve. The first batch of a new product
required 500 hours. The first four batches should take an average of
A. 361.25 hours
B. 425.0 hours
C. 500.0 hours
D. 322.4 hours

4. A learning curve of 80% assumes that production unit costs are reduced by
20% for each doubling of output. What is the cost of the sixteenth unit
produced as an approximate percent of the first unit produced?
A. 30 percent
B. 51 percent
C. 41 percent
D. 64 percent

5. Soft Inc. has a target total labor cost of P3.600 for the first four batches of a
product. Labor is paid P10 an hour. If Soft expects an 80% learning curve, how
many hours should the first batch take?
A. 360 hours
B. 140.63 hours
C. 57.6 hours
D. 230.4 hours

6. Havenot has estimated the first batch of product will take 40 hours to complete.
A 90% learning curve is expected. If labor is paid P15 per hour, the target labor
cost for four batches of product is
A. P600
B. P2, 160
C. P1, 944
D. P2, 400
7. Hanip Co. used 30 hours to produce the first batch of units TV, second batch
took an additional 18 hours. How many total hour will the first four batches
require?
A. 76.8 hours
B. 96.2 hours
C. 120.0 hours
D. 48.0 hours

8. Sulit Company plans to begin production of a new product on July 1.An 80%
learning curve is applicable to Sulit's manufacturing operations. If it is expected
to take 1,000 direct labor hours to produce the first unit, how many direct labor
hours should it take to produce the third and fourth units?
A. 640
B. 960
C. 1,600
D. 2,560

9. A construction company has just completed a bridge over the Visayan area. This
the first bridge the company ever built and it required 100 weeks to complete.
Now having hired a bridge construction crew with some experience, the
company would like to continue building bridges. Because of the investment in
heavy machinery needed continuously by this crew, the company believes it
would have to bring the average construction time to less than one year (52
weeks) per bridge to earn a sufficient return on investment. The average
construction time will follow an 80% learning curve. To bring the average
construction time (over all bridges constructed) below one year per bridge, the
crew would have to build approximately
A. 2 additional bridges.
B. 7 additional bridges.
C. 3 additional bridges.
D. 8 additional bridges.

It will take 8 bridges to complete them with cumulative average time in weeks of
below 52. The company needs to complete additional bridges to have an average
completion time of less than 52 weeks.

10. Moss Point Manufacturing recently completed and sold an order of 50 units that
had the following costs:

Direct materials P 1,500

Direct labor (1,000 hours @ P8.50) 8,500
Variable overhead (1,000 hours at P4.00) 4,000
Fixed overhead 1,400
P15,400

*Applied on the basis of direct labor hours.

* Applied at the rate of 10% of variable cost.

The company has now been requested to prepare a bid for 150 units of the
same product.

If an 80 percent learning curve is applicable, Moss Point's total cost on this

order would be estimated at
 A. P26,400
B. P37.950
C. P31,79
D. P38,500

11. Dough Distributors has decided to increase its daily muffin purchases by 100
boxes. A box of muffins costs P2 and sells for P3 through .regular stores. Any
boxes not sold through regular stores are sold through Dough's thrift store for
P1. Dough assigns the following probabilities to selling additional boxes:

Additional sales Probability

60 0.6
100 0.4
What is the expected value of Dough's decision to buy 100 additional boxes of
muffins?
A. P28
B. P40
C. P52
D. P68
12. Karen Company has three sales departments. Department A processes about 50
percent of sales, Department B about percent, and Department C about 20
percent. In the Departments A, B, and C had error rates of about 2 percent, 5
percent and 2.5 percent, respectively. A random audit (sales records yields a
recording error of sufficient magnitude distort the company's results. The
probability that Department A is responsible for this error is
A. 0.50
B. 0.33
C. 0.20
D. 0.2
13. A beverage stand can sell either softdrinks or coffee on any given day. If the
stand sells softdrinks and the weather is hot, it will make P2,500; if the
weather is cold, the profit will be PI, 000. If the stand sells coffee and the
weather is hot, it will make PI, 900; if the weather is cold, the profit will be
P2,000. The probability of cold weather on a given day at this time is 60%. The
expected payoff if the vendor has perfect information is
A. P3, 900
B. P1, 360
C. P2, 200
D. P1, 960

14. The Teeners' Club sells fresh hot cider at Recto football games. The frequency
distribution of the demand for cups of hot cider per game is presented below:

Unit sales volume Probability

10,000 0.10
20,000 0.15
30,000 0.15
40,000 0.40
50,000 0.20
 The hot cider is sold for P35.00 a cup and the cost per cup P20.00. Any unsold
hot cider is discarded because it will before the next game.

What is the estimated demand for hot cider at the next football game if a
deterministic approach based on the most likely outcome is used?
A 34, 500
B. 40, 000
C 16, 000
D. 50, 000

15. Green Co. is considering the sale of banners in an exhibit fair. Green Co. could
purchase these banners for P7.50 each. Unsold banners would be un returnable
and worthless after the exhibit. Green would have to rent a booth at the
stadium for P4,000. Green estimates sales of 2,000 banners at P20.00 each. If
Green's prediction proves to be incorrect and only 1,500 banners were sold, the
cost of this prediction error would be:
A. P 6,250
B. P10,000
C. P 4,750
D. P 3,750

16. A wine maker must decide whether to harvest grapes now or in four weeks.
Harvesting now will yield 100,000 bottles of wine netting P2 per bottle. If the
wine maker waits and the weather turns cold (probability 0.2), the yield will be
cut in half but net P3 per bottle. If the weather does not turn cold, the yield will
depend on rain. With rain (probability 0.5), a full yield netting P4 per bottle will
result. Without rain (probability 0.5), there will still be a full 100,000-bottle
yield, but the net will be only P3 per bottle.

The optimal expected value is

A. P200,000
B. P310,000
C. P350,000
D. P400,000

Question Nos. 17 and 18 are based on the following:

Sampaguita Company makes corsages that it sells salespeople on the streets. Each
sells for P2 and has variable production costs of P0.80. The salespeople receive a
P0.50 commission on each corsage they sell, and the company must P0.05 to get rid
of each unsold corsage. The corsages last for week and cannot be carried in
inventory.

The manager of the firm had estimated associated probabilities as follows:

Demand Probability
100,000 0.20
120,000 0.20
140,000 0.30
160,000 0.30

17. The optimal weekly production of the corsage is

A. 120,000
B. 140,000
 C. 134,000
D. 145,000

18. The value of perfect information is

A. P14,400
B. P16,000
C. P23,800
D. P22,100

19. The manager of Batanes Company has developed the follow probability
distribution of dairy sales of a highly perishable product. The company restocks
the product each morning
X (Units Sold P (Sales =X)
150 0.20
175 0.40
200 0.15
225 0.10
250 0.10
275 0.05
If the company desires an 85% service level in satisfying sales, should the
initial balance be for each day?
A 191
B. 225
C. 234
D. 250

20. Happy Holidays produces three products: X, Y, and Z. Two machines are used to
produce the products. The contribution margins, sales demands, and time on
each machine (in minutes) is as follows:
Demand CM Time on Ml Time on M2
X 100 P10 5 10
Y 80 18 10 5
Z 100 25 15 5

There are 2,400 minutes available on each machine during the week. How
many units should be produced and sold maximize the weekly contribution?

X Y Z
A. 100 80 100
B. 20 80 100
C. 100 40 100
D. 100 80 73

Question Nos. 21 through 24 are based on the following information:

Glassco, Inc. has two products, a frozen dessert and ready-to-bake breakfast rolls,
ready for introduction. However, plant capacity limited, and only one product can be
introduced at present. Therefore Glassco has conducted a market study, at a cost of
P26,000 to determine which product will be more profitable. The results of' the study
show the following sales patterns.
 Sales of Desserts at Sales of Rolls at P1.20 per
P1.80 per unit unit

Volume Probability Volume Probability

250,000 .30 200,000 .20
300,000 .40 250V000 .50
350,000 .20 300,000 .20
400,000 .10 350,000 .10

The costs associated with the two products have been estimated by Glassco's cost
accounting department and are shown below:
Dessert Rolls
Ingredients per unit P 0.40 P 0.25
Direct labor per unit 0.35 0.30
Variable overhead per unit 0:40 0.20
Production tooling* 48,000.00 25,000.00
Advertising 30,000.00 20,000.00

* Glassco treats production tooling as a current operating expense rather than

capitalizing it as a fixed asset.
21. According to Glassco's market study, the expected value of sales volume of the
breakfast rolls is
A. 125,000 units
B. 275,000 units
C. 260,000 units
D. 250,000 units
22. Applying a deterministic approach, Glassco's revenue from sales of frozen
desserts would be
A. P549,000
B. P195,000
C. P540,000
D. P2 16,000
23. The expected value of Glassco's operating profit directly traceable to the sale of
frozen desserts is
A. P198, 250
B. P150, 250
C. P47 1,000
D. P120, 250

24. In order to recover the costs of production tooling and advertising for the
breakfast rolls, Glassco's sales of the breakfast rolls would have to be
A. 37, 500 units
B. 60,000 units
C. 100,000 units
D. 54,000 units
Question Nos. 25 through 30 are based on the following:
KMU Company uses a small casting in one of its finished products. The castings are
purchased from a foundry located in another Asian Country. In total, KMU Company
purchases 54,000 castings per year at a cost of P8 per casting.
The castings are used evenly throughout the year in the production process on a
360-day-per-year basis. The company estimates that it costs P90 to place a single
purchase order and about P3 to carry one casting in inventory for a year. The high
carrying costs result from the need to keep the castings in carefully controlled
temperature and humidity conditions, and from the high cot of insurance.
Delivery from the foundry generally takes 6 days, but it can take as much as 10
days. The days of delivery time and the percentage of their occurrence are shown in
the following tabulation:

Delivery Time (days) Percentage of Occurrence

6 75
7 10
8 5
9 5
10 5
100
25. What is the economic order quantity for the company.
A. 1,800
B. 1273
C. 2,545
D. 2,700
26. Assuming that the company will not provide any safety stock units, how much
would the annual inventory costs?
A. P2.700
B. P8,100
C. P5,400
D. P6,000
27. Assuming that the company is willing to assume a 15% risk of being out of
stock, what would be the number of safety stock?
A. 0
B. 150
C. 300
D. 450
28. Assuming that the company is willing to assume only a 5% being out of stock,
what would be-the reorder point?
A. 450
B. 1,050
C. 1,200
D. 1,350

29. Assuming a 5% stock-out risk, what would be the total cost of ordering and
carrying inventory for one year?
A. 5,850
B. 6,300
C. 6,075
D. 6,750

30. Assuming that the cost of stock out is P800 per occurrence, which safety stock
level is necessary in reducing the cost?
A. 0
 B. 150
C. 300
D. 450

31. At the beginning of 2007, Silang Company installed a JIT purchasing and
manufacturing system. The following information has been gathered about one
of the company's products
Theoretical annual capacity 4,000
Actual production 3,800
Production hours available 2,500
On-time deliveries 1,500
Total deliveries 1,600
Scrap (lbs.) 400
Materials used (lbs.) 12,800
Number of defective units 20
Defective units as a percentage of total units produced is:
A. 5%
B. 1.05%
C. 0.53%
D 2.5%