MANAGEMENT ADVISORY SERVICES

EXERCISES
Working Capital Policy
1
. Real Company has P8,000,000 in current assets, P3,500,000 of which are considered
permanent current assets. In addition, the firm has P6,000,000 invested in fixed assets. Real
Company wishes to finance all fixed assets and permanent current assets plus half of its
temporary current assets with long-term financing costing 15 percent. Short-term financing
currently costs 10 percent. Real Company's earnings before interest and taxes are
P2,200,000. Income tax rate is 40 percent.

Working Capital Management

A. What was Amores total debt in 2002?
B. How much new, long-term debt financing will be needed in 2003?
4

How much would Real Company's earnings after taxes under this financing plan?
2

A firm that is in the process of preparing its financial plan for the upcoming year has estimated
the following current assets (in P000,000) for the year.
Month
CA
Month
CA
Month
CA
Jan
19.2
May
36.6
Sept
26.9
Feb
21.6
June
43.8
Oct
25.5
Mar
24.5
Jul
40.5
Nov
23.4
Apr
33.4
Aug
34.4
Dec
20.7

The KRAM Company had the following data for the current year, 2004:
Sales, 2004
Sales, 2005
Items that vary directly with sales:
Assets
Liabilities
Net profit margin
Payout ratio

1. Compute the projected additional financing needed for 2005.

2. Compute the projected additional financing needed for 2005 under each assumption:
A. Payout ratio is 55%

1. How much will the firms permanent level of assets be for the coming year?

C. Sales next year is P5,000,000 and the payout ratio is 40%.

3. Compute the maximum temporary financing requirement of the firm.

External Financing Needed
3
. At year-end 2002, total assets for Amore Inc. were P1.2 million and accounts payable were
P375,000. Sales, which in 2002 were P2.5 million, are expected to increase by 25% in 2003.
Total assets and accounts payable are proportional to sales, and that relationship will be
maintained. Amore typically uses no current liabilities other than accounts payable. Common
stock amounted to P425,000 in 2002, and retained earnings were P295,000. Amore plans to
sell new common stock in the amount of P75,000. The firms profit margin on sales is 6
percent, 60 percent of earnings will be retained.
Exercises & Problems

45%
15%
15%
45%

Required:

The firms fixed assets should remain constant at P40 million. Owners equity is forecast to be
P25 million. Working capital policy requires that 50% of maximum current assets be financed
with permanent financing.

2. Compute the permanent financing requirement of the firm.

P4,000,000
5,500,000

B. Net profit margin is 10% and payout ratio is 30%

The 2003 sales of Reign Co. amounted to P8 million. The dividend payout ratio is 30%. The
percent of sales in each balance sheet item that varies directly with sales are expected to be
as follows:
Cash
8%
Receivables
15%
Inventories
16%
Net fixed assets
30%
Accounts payable
12%
Accrued expenses
6%
Net profit rate
9%
Required:
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Working Capital Management

A. Suppose that in 2004 sales increased by 25% over 2003 sales. How much additional
(external) capital will be required?

C. Calculate the amount of negotiated financing required to support the firms cash
conversion cycle.

B. What would happen to capital requirement if Reign can increase its sales by 40% and the
payout ratio is increased to 40%?

D. How could management reduce the cash conversion cycle?

8

A firm that has an annual opportunity cost of 12% is contemplating installation of a lockbox
system at an annual cost of P90,000. The system is expected to reduce mailing time by 2
days, reduce processing time by 1.5 days, and reduce check clearing time by 1 day. If the firm
collects P300,000 per day, would you recommend the system?

Calma Company uses a continuous billing system that results in average daily receipts of
P750,000. The company treasurer estimates that a proposed lock-box system could reduce its
collection time by 2 days.

Cash Management
6
. Samson Corporation, a leading producer of automobile batteries, turns out 1,500 batteries a
day at a cost of P600 per battery for materials and labor. It takes the firm 22 days to convert
raw materials into a battery. Samson allows its customers 40 days in which to pay for the
batteries, and the firm generally pays suppliers in 30 days.

A. What is the length of Samson's cash conversion cycle?

B. At a steady state in which Samson produces 1,500 batteries a day, what amount of
working capital must it finance?

A. How much cash would the lock-box system free up for the company?
B. What is the maximum amount that Calma would be willing to pay for the lock-box system
if it can earn 6 percent on available short-term funds?

C. By what amount could Samson reduce its working capital financing needs if it was able to
stretch its payables deferral period to 35 days?
D. Samson's management is trying to analyze the effect of a proposed new production
process on the working capital investment. The new production process would allow
Samson to decrease it s inventory conversion period to 20 days and to increase its daily
production to 1,800 batteries. However, the new process would cause the cost of
materials and labor to increase to P700. Assuming the change does not affect the
receivables collection period (40 days) or the payables deferral period (30 days), what will
be the length of the cash conversion cycle and the working capital financing requirement if
the now production process is implemented?
7

Abbey Products is concerned about managing cash efficiently. On the average, inventories
turns over 5 times, and accounts receivable are collected in 60 days. Accounts payable are
paid approximately 30 days after they arise. The firms spends P30 million on operating cycle
investments each year, at a constant rate. Assuming a 360-day year.
A. Calculate the firms operating cycle
B. Calculate the firms cash conversion cycle

Exercises & Problems

C. If the lock-box system could be arranged at an annual cost of P45,000, what would be the
net gain from instituting the system?
10

. Syl Company projects that cash outlays of P45 million will occur uniformly throughout the year.
Syl plans to meet its cash requirements by periodically selling marketable securities from its
portfolio. The firms marketable securities are invested to earn 12 percent, and the cost per
transaction of converting securities to cash P30.
A. What is the optimal transaction size for transfer from marketable securities to cash?
B. What will be Syls average cash balance?
C. Compute the annual cost of cash based on optimal transaction size

Receivables Management
11
. McPan Company sells on terms of 3/10, net 30. Total sales for the years are P900,000. Forty
percent of the customers pay on the 10th day and take discounts; the other 60 percent pay, on
average, 40 days after their purchases. Assume 360 days per year.
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A. What is the days sales outstanding?

Working Capital Management

16

. The Electra Car Company purchases 20,000 units of a major component part each year. The
firm's order costs are P200 per order and the carrying cost per unit is P2 per year.

B. What is the average amount of receivables?

A. Compute the total inventory costs associated with placing orders of 20,000, 10,000,
5,000, 1,000.

C. What would happen to average receivables if McPan toughened up on its collection policy
with the result that all no-discount customers paid on the 30th day?

B. Determine the EOQ for the component parts.

12

. S Mart has sales of P3 million. Its credit period and average collection periods are both 30
days, and 1.5% of its sales end as bad debts. The manager intends to extend the credit term
to 45 days which will increase sales to P3.3 million. However, bad debt losses on the
incremental sales would be 3%. Costs of products and related expenses amount to 40%,
exclusive of the cost of carrying receivables of 15% and bad debt expenses. Assuming 360
days a year, what incremental cost of investment is required to support the change in policy?

17

. Ever Company is considering switching from level production to seasonal production in order
to lower very high inventory costs. Average inventory levels would decline by P300,000 but
production costs would rise about P40,000 because of additional startups and other
inefficiencies. The firm's cost of financing inventory balances is 15%.
A. Should the firm switch to seasonal production? (ignore income taxes)

13

. Dessa, Inc. currently has sales of P2.5 million. Its credit period and days sales outstanding
(DSO) are both 30 days, and 1 percent of its sales end up as bad debts. The credit manager
estimates that, if the firm extends its credit period to 45 days so that its days sales outstanding
increases to 45 days, sales will increase by P250,000, but its bad debt losses on the
incremental sales would be 2.5 percent. Variable costs are 60 percent, and the cost of carrying
receivables, k, is 12.5 percent. Assume a tax rate of 40 percent and 360 days per year.
A. Compute the incremental investment required to finance the increase in receivables if the
change is effected.
B. What would be the incremental cost of carrying receivables?
C. What would be the effect of those changes in net income?

Inventory Management
14
. Wilbur Co. last year reported sales of P10,000,000 and an inventory turnover ratio of 2. The
company is now adopting a just-in-time inventory system. If the new system is able to reduce
the firm's inventory level and increase the firm's inventory turnover to 5, while maintaining the
same level of sales, how much cash will be freed up?

B. At what interest rate would the cost of financing additional inventory under level
production be equal to the added production costs of seasonal production?(ignore income
taxes)
C. Answer (A) and (B) if the applicable income tax rate is 40 percent.
Trade Credit
18
. Cash discount Decisions. The credit terms for each of three suppliers are shown below:
Supplier A
Supplier B
Supplier C
Supplier D

2/10 n/55
3/10 n/55
2/15 n/45
2/10 n/30

A. Determine the annual approximate cost of giving up the cash discount from each supplier.
B. Assuming that the firm needs short-term financing, recommend whether it would be better
to give up the cash discount or take the discount and borrow from a bank at 20% annual
interest. Evaluate each supplier separately using your findings in Question A.

15

. Tri Company's financial plan for next year- shows sales of P72 million and cost of sales of P45
million. It expects short-term interest rates to average 10% for the coming year. It aims to
increase inventory turnover form the present 9 times to 12 times next year. How much is the
incremental benefits in form of cost savings that can be achieved from the plan?

Exercises & Problems

C. Assuming that the entity continuously foregoes the cash discount, compute the annual
effective cost of giving up the discount on each supplier.
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Working Capital Management

Short-term Loan
19
. Divina Mendez, owner of DM Company is negotiating with Island City Bank for a P1M, 1-year
loan. Island City Bank has offered DM Company the following alternatives. Calculate the
effective annual interest rate for each alternative. Which alternative has the lowest effective
annual interest rate?

60. Barangay Bank has agreed to lend the money at a 12% rate with a 15% compensating
balance requirement. Townbank will lend at a 13% interest rate on a discounted loan from
three months.
A. What is the effective rate of interest charged by each bank?

A. A 12.5 percent annual rate on a simple interest loan, with no compensating balance
required and interest due at the end of the year.

B. What is the cost of foregoing the discount?

C. How much would Tyler have to borrow from each bank in order to take the discount?

B. A 9.25 percent annual rate on a simple interest loan, with a 20 percent compensating
balance required and interest again due at the end of the year.

D. Suppose that Tyler normally banks with Barangay Bank and maintains deposit balance of
P15,000, what amount would have to be borrowed and what would the effective interest
rate be?

C. A 8.75 percent annual rate on a discount loan, with a 20 percent compensating balance.
D. A 8.75 percent annual rate on a discount loan, with a 20 percent compensating balance
and an existing cash balance of P150,000
E. A 8.75 percent annual rate on a discount loan, with a 20 percent compensating balance
which earns 5% interest income.
F. A 8.75 percent annual rate on a discount loan, with a 20 percent compensating balance
and an existing cash balance of P150,000. The bank balance earns 5% interest income.
Redo requirement (A) to (F) assuming the loan is for four (4) months.
Short-term Financing Alternatives
20
. Lance Hardware can buy equivalent materials from two-distributors. Supplier A offers term
1/10, net 30 whereas Supplier B provides terms of 2/15, net 60.

22

. Dela Merced, owner of DM Company is negotiating with Island City Bank for a P500,000, 1year loan. Island City Bank has offered DM Company the following alternatives. Calculate the
effective annual interest rate for each alternative. Which alternative has the lowest effective
annual interest rate?
A. A 12 percent annual rate on a simple interest loan, with no compensating balance
required and interest due at the end of the year.
B. A 9 percent annual rate on a simple interest loan, with a 20 percent compensating
balance required and interest again due at the end of the year.
C. An 8.75 percent annual rate on a discount loan, with a 15 percent compensating balance.
D. Interest is figured as 8 percent of the P50,000 amount, payable at the end of the year, but
the P50,000 is repayable in monthly installments during the year.

A. If Lance foregoes the discount, which of the two suppliers should it purchase from if
supply prices are comparable.
B. If Lance can borrow from Lending Bank at a 16%, should it forego the discount?
C. If in (B) above the bank requires a 20% compensating balance for the loan, should the
firm forego the discount?
21

. Tyler Company needs P100,000 to take advantage of a discount based on terms of 3/10, net

Exercises & Problems

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Working Capital Management

MULTIPLE CHOICE
1. May Co. has total fixed assets of P100,000 and no current liabilities. The table below displays
its wide variation in current asset components.
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
Cash
P 20,000
P 10,000
P 15,000
P 20,000
Accounts receivable
66,000
25,000
47,000
88,000
Inventory
20,000
65,000
59.000
10,000
Total
P106,000
P100,000
P121,000
P118,000
If May's policy is to finance all fixed assets and half the permanent current assets with longterm financing and rest with short time-financing, what is the level of long-term financing?
A. P68,000
C. P150,000
B. P100,000
D. P155,625
2. Silver Company has the following ratios: A*/S = 1.6; L*/S = 0.4: profit margin = 0.10; and
dividend payout ratio = 0.45, or 45 percent. Sales last year were P100 million. Assuming that
these ratios will remain constant and that all liabilities increase spontaneously with increases in
sales, what is the maximum growth rate Silver Company can achieve without having to employ
nonspontaneous external funds?
*Spontaneous assets and liabilities
A. 3.9 percent
C. 7.8 percent
B. 4.8 percent
D. 9.6 percent
3. Color Paint Company has plants in 3 major cities. Sales for last year were P100 million, and
the balance sheet at year-end is similar in percentage of sales to that of previous years (and
this will continue in the future). All assets (including fixed assets) and current liabilities will vary
directly with sales. Color Paint is already using assets at full capacity.
Balance Sheet (In million pesos)
Assets
Current assets

P50

Fixed assets
Total.

40
P90

Liability and Stockholders Equity

Accounts payable and accruals
Notes payable - long term
Common stock
Retained earnings
Total

P25
30
15
20
P90

Color Paint has an after-tax profit margin of 5 percent and a dividend payout ratio of 30
Exercises & Problems

percent.
If sales grow by 10 percent next year, the required new financing (RNF) to finance the
expansion is
A. P4,850,000
C. P2,650,000
B. P3,000,000
D. P5,000,000
4. The Gold 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
C. 113 days
B. 67 days
D. 45 days
5. Texas 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.
Texas usual credit terms 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 Texas
finance?
A. P1,400,000
C. P2,400,000
B. P900,000
D. P1,800,000
6. Hep Inc., has a total annual cash requirement of P9,075,000 which are to be paid uniformly.
Hep has the opportunity to invest the money at 24% per annum. The company spends, on the
average, P40 for every cash conversion to marketable securities.
What is the optimal cash conversion size?
A. P60,000
C. P45,000
B. P55,000
D. P72,500
7. Collectrite Company 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
C. P77,200
B. P77,500
D. P67,500
8. Palma 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. Palma 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 will result in an expected increase in the average accounts receivable balance of
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A. P540,000
B. P2,700,000

Working Capital Management

C. P900,000
D. P1,620,000

9. The Tempo 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 Tempo's variable cost ratio is
60 percent and annual fixed costs of P600,000. The current cost of capital for Tempo is 12%. If
Tempo's annual sales are P3,375,000 and all sales are on credit, what is the firm's carrying
cost on accounts receivable, using 360 days year?
A. P281,250
C. P20,250
B. P168,750
D. P56,250
10. Globe, Inc. 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 Globe'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.
Globe'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
What are the days sales outstanding (DSO) before- and after the- change of credit policy?
A. 27 days and 22.5 days, respectively
C. 22.5 days and 27 days, respectively
B. 22.5 days and 21.5 days, respectively
D. 21.5 days and 22.5 days respectively
11. If a firm purchases raw materials from its supplier on a 2/10, n/50 term, the equivalent annual
effective interest (using 360-day year) of continuously giving up a cash discount and making
payment on the 50th day is
A. 14 percent
C. 12.29 percent
B. 19.94 percent
D. 14.69 percent
Questions 12 & 13 are based on the following information.
A firm buys on terms of 2/10, net 30, but generally does not pay until 40 days after the invoice date.
Its purchases total P1,080,000 per year.

12. How much "non-free" trade credit does the firm use on average each year?
A. P120,000
C. P60,000
B. P90,000
D. P30,000
13. What is approximate cost of the "non-free" trade credit?
A. 16 2%
C. 21.9%
B. 19.4%
D. 24.5%
14. A company obtained a short-term bank loan of P500,000 at an annual interest rate of 8%. As a
condition of the loan, the company is required to maintain a compensating balance of
P100,000 in its checking account. The checking account earns interest at an annual rate of
3%. Ordinarily, the company maintains a balance of P50,000 in its account for transaction
purposes. What is the effective interest rate of the loan?
A. 7.77%
C. 9.44%
B. 8.50%
D. 8.56%
Questions 15 thru 18 are based on the following information.
You plan to borrow P100,000 from your bank, which offers to lend you the money at a 15 percent
nominal, or stated, rate on a 1-year loan.
15. What is the effective interest rate if the loan is discount loan?
A. 17.65%
C. 17.50%
B. 13.00%
D. 30.00%
16. What is the approximate effective interest rate if the loan is an add-on interest loan with 12
monthly payments?
A. 17.65%
C. 20.00%
B. 15.00%
D. 26.50%
17. What is the effective interest rate if the loan is a discount loan with a 10 percent compensating
balance?
A. 17.65%
C. 17.50%
B. 20.00%
D. 26.50%
18. Under the terms of question no. 17, how much would you have to borrow to have the use of
P100,000?
A. P100,000
C. P120,000
B. P111,110
D. P133,333

Exercises & Problems

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Working Capital Management

19. Three suppliers of baseball equipment offer different credit terms to City Sports. X Co. offer
terms of 1 / 15, net 30. Y Enterprises offers terms of 1/10, net 30. Z Inc. offers terms of 2/10,
net 60. City Sports would have to borrow from a bank at an annual rate of 10% in order to take
any cash discounts. Which one of the following would be the most attractive for City Sports?
A. Purchase from X and pay in 30 days
B. Purchase from X, pays in 15 days, and borrows any money needed from the bank
C. Purchase from Y and pay in 30 days
D. Purchase from Z and pay in 60 days
20. Gees Pipeline, Inc., has developed plans for new pump that will allow more economical
operation of the companys oil pipelines. Management estimates that P2,400,000 will be
required to put this new pump into operation. Funds can be obtained from a bank at 10
percent discount interest, or the company can finance the expansion by delaying to payment
to its suppliers. Presently, Gees purchases under terms of 2/10, net 40, but management
believes payment could be delayed 30 additional days without penalty; that is, payment could
be made in 70 days. Which means of financing should Gees use? (Use the approximate cost
of trade credit.)
A. Trade credit, since the cost is about 12.24 percent.
B. Trade credit, since the cost is about 3.13 percentage points less than the bank loan
C. Bank loan, since the cost is about 1.13 percent points less than trade credit
D. Bank loan, since the cost is about 3.13 percentage points less than trade credit
SOLUTIONS

Exercises & Problems

Page 7 of 9

. 1.
2. Permanent financing = 61,900,000
3. Max. temporary financing = 21,900,000

. A.
P480,000
(1,200,000 295,000 425,000)
B. P18,750
(206,250 112,500) 75,000

127,500
Permanent assets = 59,200,000 (40,000,000 + 19,200,000)
(40,000,000 + 43,800,000 x 0.50)
(43,800,000 x 0.5)

1
2a
2b
2c
Inc in SNA450,000.450,000.450,000.300,000Inc in RE(453,750)(311,250)(385,000)(450,000)
(3,750)78,75065,000(150,000)
.
(a)
(b)
Inc in SNA1,020,0001,632,000Inc in RE(630,000)(604,800)390,0001,027,200
. A.
Cash conversion cycle = 32 days (22 + 40 30)
B. 28.8 million
(1,500 x 600 x 32)
C. 4.5 million
(35 30) x 1,500 x 600
D. New CCC = 30 days
(20 + 40 30)
WC 37.8 million
1,800 x 700 x 30

.
B.
C.
D.

. A.
P1,500,000
(P750,000 x 2)
B. P90,000
P1,500,000 x 6%
C. P45,000
P90,000 P45,000

10

. A.
P150,000
B. P75,000
C. P18,000

11

. A.
B. AR = 70,000
C. AR = 55,000

A.
132 days
(72 + 60)
102
(132 30)
8.5 M
(30 M x 102/360
reduce days AR (increase AR turnover), reduce days inventory(increase inventory turnover), increase days AP
72,000

(300,000 x 4.5 days x 12%) 90,000

DSO = 28 days (10 x 40%) + (40 x 60%)

(900,000/360 x 28)
DSO = 22 days (10 x 40% +30 x 60%)

12

OldNewChangeP&L EffectSales3,000,0003,300,000300,000x 60%180,000Bad debts %S1.5%

3%Bad
debts45,0009,000(9,000)DSO3045AR250,000412,500162,500VC ratiox 40%Inc. in AR Invt65,000x 15%(9,750)Inc. Inc
bef tax161,250
13

OldNewChangeP&L EffectSales2,500,0002,750,000250,000x 0.4100,000Bad debtsx

2.5%(6,250)DSO3045AR208,333343,750135,417
x 0.6Inc. in AR Invt81,250.20x 12.5%(10,156.28)Inc. Inc bef
tax83,593.720.6Incl Net Income50,156.23
14
. 3,000,000
OldNewDiffSales10 million10 millionInventory turnover25Inventory5,000,0002,000,0003,000,000
15
. 125,000 (1,250,000 x 10%)
OldNewDiffCost of Sales45 million45,000,000Inventory turnover912Inventory5,000,0003,750,0001,250,000
16
. A.
Order Size# of ordersOrder CostCarrying CostTotal20,0001 20020,00020,20010,0002 40010,00010,400 5,0004 800
5,000 5,800 1,000204,000 1,000 5,000

2(20,000)(200

B. 2,000
17

. A.
B. 13.33%
C. Answer is the same

Yes, cost savings of 5,000 (300,000 x 15%) 40,000

(40/300)

18

.
daysXNominalEffectiveSupplier A2/10 net 5545816.33%17.54%Supplier B3/10 net 5545824.74%27.59%Supplier C2/15
net 45301224.49%27.43%Supplier D2/10 net 30201836.73%43.86%
19
.
One-year4-monthsA.12.5%12.5%B.11.5625%
9.25 8011.5625%C.12.28%
20)11.35%D.10.145%9.5%E.10.88%10.05%F.9.86%9.23%

8.75

20

. A.
Supplier A = 18.18%
Supplier B = 16.33%
B. Borrow at 16%, pay supplier within discount period
C. 20% (16/80), Yes, forego the discount.

21

A.
Barangay Bank = 14.12%
Townbank = 13.44%
(3.25/96.75) x 4
B. Trade discount = 22.27%
C. Barangay Bank = 117,647 (100,000 0.85)
Townbank = 103,359 (100,000 0.9675)
D. Principal = 100,000,
Effective interest rate = 12%

(12/85)

22

. A.
B. 11.25%

1148% 8.75/(100 8.75 15)

8/50

9/80

12%
C.
D. 16%

(100 8.75