WORKING CAPITAL MANAGEMENT

THEORIES (20 pts.)

1. 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 higher price.
C. The items purchased have a lower price.
D. The supplier offers a longer discount period.

2. 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

3. Temporary working capital supports

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

4. The transaction motive for holding cash is for:

A. a safety cushion C. compensating balance requirements
B. daily operating requirements D. none of the above

5. The difference between the cash balance on the firm's books and the balance shown on
the bank statement is called:
A. A. the compensating balance C. a safety cushion
B. B. float D. none of the above

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

7. 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. increases its cash balance

8. 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.

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

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

11. 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 ROE.
D. the company's total asset turnover ratio would probably decline.
12. All but which of the following is considered in determining credit policy?
A. A. Credit standards C. Accounts payable deferral period
B. B. Credit limits D. Collection efforts

13. The use of safety stock by a firm will:

A. A. reduce inventory costs C. have no effect on
inventory costs
B. B. increase inventory costs D. none of the above

14. 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

15. 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

16. With credit terms of 3/8, n/30, what is the customer’s payment 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.

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. 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.

19. 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.

20. 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. Increase in the operating cycle.
C. Decrease in the operating cycle.
D. Increase in the ratio of current assets to current liabilities.
PROBLEMS (30 pts.)

1. A firm has a cash conversion cycle of 60 days. Annual outlays are P12 million and the
cost of negotiated financing is 12 percent. If the firm reduces its average age of
inventory by 10 days, the annual savings is _________.
a. P104,000
b. P144,000
c. P 28,800
d. P40,000

2. The Steel Works, Inc. is required to carry a minimum of 40 days’ raw steel, which is 250
tons. It takes 15 days between order and delivery. At what level of steel would Steel
Works reorder?
a. 3,750 tons
b. b. 600 tons
c. 667 tons
d. 344 tons

3. The General Chemical Company uses 150,000 gallons of hydrochloric acid per month.
The cost of carrying the chemical in inventory is 50 cents per gallon per year, and the
cost of ordering the chemical is P150 per order. The firm uses the chemical at a constant
rate throughout the year. The chemical’s economic order quantity is:
a. 32,863 gallons.
b. 11,619 gallons.
c. 9,487 gallons.
d. 1,900 gallons.

4. Contex, Inc. uses 800 units of a product per year on a continuous basis. The product
has carrying costs of P50 per unit per year and order costs of P300 per order. It takes 30
days to receive a shipment after an order is placed and the firm requires a safety stock
of 5 days usage in inventory. Calculate the economic order quantity (EOQ).
a. 98 units
b. 69 units
c. 56 units
d. 100 units

5. Sharon uses 35 baskets each day to pack apples for shipping. It takes 5 days to receive
a shipment of baskets after an order is placed and she would like a safety stock of 3
days in inventory. At what level of inventory should Sharon place an order for baskets?
a. 175 units
b. 180 units
c. 260 units
d. 280 units

6. Data products, Inc., uses 2,400 units of a product per year on a continuous basis. The
product carrying costs are P60 per year and ordering costs are P250 per order. It takes
20 days to receive a shipment after an order is placed and the firm requires a safety
stock of 8 days of usage in inventory. Calculate the total cost per year to order and carry
this item.
a. P8,485
b. P8,125
c. P7,560
d. P7,000

7. The General Chemical Company uses 150,000 gallons of hydrochloric acid per month.
The cost of carrying the chemical in inventory is 50 cents per gallon per year, and the
cost of ordering the chemical is P150 per order. The firm uses the chemical at a constant
rate throughout the year. It takes 18 days to receive an order once it is placed. The
reorder point is:
 a. 7,500 gallons.
b. 25,000 gallons.
c. 90,000 gallons.
d. 105,000 gallons.

8. 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 C. 54 days
B. 75 days D. 105 days

9. A company obtained a short-term loan from a bank. Some information about the credit
line is as follows:
Principal P5,000,000
Stated Interest Rate 10%
Terms 1 year

If the loan is discounted, the effective interest rate is:

a. 10%
b. 11.11%
c. 9.09%
d. 8.89%

10. Dennis, Inc. purchased an item on credit with terns of 3/10, net 45. Based on a 360-day
year, the company’s interest cost of foregoing the cash discounts and making payment
on the last day of the credit period is:
A. 24.00% C. 24.74%
B. 31.81% D. 30.86%

11. Flint Company’s average collection period is 20 days. The average daily sales is P5,000.
All of the company’s customers pay by credit card. How much is the company’s average
accounts receivable balance?
a. P0
b. P100,000
c. P50,000
d. P5,000

12. Dennis, Inc. has an inventory conversion period of 60 days, a receivable conversion
period of 35 days, and a payment cycle to 26 days. If its sales for the period just ended
amounted to P972,000, what is the investment in accounts receivable? (Assume 360
days in a year).
A. P85,200 C. P94,500
B. P72,450 D. P79,600

13. Pert Company 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 they pursue this opportunity, the after-tax profit will:
A. Increase by P35,000 C. Increase by P65,000
B. Increase by P97,500 D. Remain the same.

14. Mr. R. Sim assumed the presidency of Green Corp. he instituted new policies with
respect to credit policy. Below is a summary of relevant information:
Credit policy
Old New
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. P4,800,000 C. P3,000,000
 B. P2,880,000 D. P4,080,000
15. The Green sales Company’s budgeted sales for the coming year are P30 million of
which 80% are expected to be made 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
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. P600,000 C. P480,000
B. P288,000 D. P192,000

ANSWER KEY:
THEORIES
1. D 8. D 15. A
2. B 9. D 16. B
3. D 10. C 17. C
4. B 11. B 18. B
5. B 12. C 19. C
6. D 13. B 20. D
7. B 14. D

PROBLEMS
1. D 6. A 11. B
2. D 7. C. 12. C
3. A 8. B 13. C
4. A 9. B 14. B
5. D 10. B 15. D