ReSA -The Review School of Accountancy Management Services

MS-11: FINANCIAL MANAGEMENT

FINANCIAL MANAGEMENT- concerns the duties of the financial manager, who is responsible for making significant corporate
investment and financing decisions.

GOAL OF FINANCIAL MANAGEMENT

Modern managerial finance theory works under the premise that the primary goal of the firm is to maximize
shareholders wealth, rather than to maximize profit. The financial manager acts in the shareholders best interests by making
decisions that maximize the market value per share of stock.

ROLE OF FINANCIAL MANAGERS

The role of a financial manager may include, but is not limited to, the following tasks:
1. Financial analysis and planning. Determining the proper amount of funds to employ in the firm through liquidity
and profitability analysis of the companys financial statements. (related topics: budgeting, financial statement
analysis and additional funds needed)
2. Investments decisions. Selecting the best projects in which to invest firm resources, based on consideration of risks
and returns. (related topic: capital budgeting)
3. Financing and capital structure decisions. Outsourcing company funds (mix of debt and equity financing) to
support firms operations and investment programs. (related topic: costs of capital)
4. Management of financial resources. Managing the firms current assets and source of short-term credit in the most
efficient manner. (related topic: working capital management)
5. Risk management. Managing the firms exposure to all types of risk. (related topic: leverage)

No single person is tasked for all the responsibilities of a financial manager. These tasked are dispersed throughout the
firm. In large firms, financial responsibilities are usually carried out by the treasurer and/or the controller. The chief financial
officer (CFO) usually oversees the work of both treasurer and controller.

BASIC PRINCIPLES IN MANAGERIAL FINANCE

Most techniques and tools in finance are based on the following theoretical axioms or principles:
Risk-return trade-off: we wont take on additional risk unless we expect to be compensated with additional return
Time value of money: a peso received today is worth more than a peso received in the future.
Cash not profit is king.
Incremental cash flows its only what changes that counts
Tax consideration: virtually all financial decisions are influenced by the effect of taxes.
Ethical behavior doing the right thing is always relevant.

WORKING CAPITAL MANAGEMENT

WORKING CAPITAL MANAGEMENT - involves managing the firms current assets and liabilities to achieve a balance
between profitability and risk that contributes positively to the firms value.
RISK RETURNS
The management of net working capital requires consideration for the trade-off between risk and returns. Holding more
current than long-term assets means greater flexibility and reduced liquidity risk. However, the rate of return will be less than with
current assets that with long-term assets. Long-term assets typically earn a greater return than current assets. Long-term financing has
less liquidity risk associated with it than short-term debt, but the former also carries a higher cost. Consider the following:

Working Capital Policy

Conservative Aggresive
Level of Current Assets HIGH LOW
Reliance on Long-Term Financing HIGH LOW
Liquidity Task LOW HIGH
Profitability and Returns LOW HIGH

CONSERVATIVE AGGRESIVE

CURRENT CURRENT
CURRENT LIABILITIES ASSETS CURRENT
ASSETS LIABILITIES
ReSA -The Review School of Accountancy MS- 11
FINANCIAL MANAGEMENT

EXERCISE WORKING CAPITAL

Given the following information of Ana Company:
Cash P 18, 000 Accounts Payable P 10, 000
Accounts Receivable 12, 000 Accrued Payroll 3, 000
Inventory 20, 000 Current Tax Liability 7, 000
Fixed Assets 50, 000 Bonds Payable 40, 000

NOTE: Bonds will mature in 10 years.

REQUIRED:
1. What is the net working capital?
2. Determine the companys current ratio.
3. If only the quick assets are considered, then what is the acid-test ratio?
4. Assuming the entire accounts payable are paid in cash, what is the new current ratio?
5. Assuming a P 10,000 short-term loan is obtained from a bank, what is the new current ratio?

FACTORS TO CONSIDER IN MANAGING WORKING CAPITAL

APPROPRIATE LEVEL This refers to adequacy of working capital
Consider: Nature of business and length of operating cycle
STRUCTURAL HEALTH This refers to composition of working capital
Consider: Need of cash and stock of inventory units
LIQUIDITY This refers to the relative transformation (and its rate) of current assets into more liquid
current assets (e.g., cash and marketable securities).

In general, sound working capital policy requires:

Managing cash and its temporary investment efficiently. (Cash/Marketable Securities Management)
Ensuring efficient manufacturing operations and sound material procurement. (Inventory Management)
Drafting and implementing effective credit and collection policies. (Receivable Management)
Seeking favorable terms from suppliers and other temporary creditors. (Short-term Credit Financing)

CASH & MARKETABLE SECURITIES (MS) MANAGEMENT

CASH MANAGEMENT - involves the maintenance of the appropriate level of cash to meet the firms cash requirements and to
maximize income on idle funds.

MS MANAGEMENT - involves the process of planning and controlling investment in marketable securities to meet the firms
cash and to maximize income on the idle funds.

OBJECTIVE: To minimize the amount of cash on hand while retaining sufficient liquidity to satisfy business requirements (e.g., take
advantage of cash discounts, maintain credit rating, meet unexpected needs).

REASONS FOR HANDLING CASH Why would a firm hold cash when, being idle, it is a non-earning asset?
1. TRANSACTION motive (Liquidity motive)
Cash is held to facilitate normal transactions of the business.
2. PRECAUTIONARY motive (Contingent motive)
Cash is held beyond the normal operating requirement level to provide for the buffer against contingencies, such
as slow-down in accounts receivable collection and possibilities of strikes.
3. SPECULATIVE motive
Cash is held to avail of business incentives (e.g., discounts) and investment opportunities.
4. CONTRACTUAL motive Compensating Balances Requirements
A company is required by a bank to maintain a certain compensating balance in its demand deposit account as a
condition of a loan extended to it.

OPTIMAL CASH BALANCE: BAUMOL MODEL

2 (Annual Cash Requirement)(Cost Per Transaction)
OPTIMAL CASH BALANCE (OCB) =
Opportunity Cost of Holding Cash

Total Costs of Cash Balance = Holding Costs + Transactions Costs

HOLDING Costs = Average cash balance * x opportunity cost
TRANSACTION Costs = Number of transactions** x Cost per transaction
*Average cash balance = OCB 2
**Number of transactions = Annual cash Requirement OCB
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FINANCIAL MANAGEMENT
6. Greece Inc. is going to begin factoring its accounts receivable and has collected information on the following four finance
Companies:
Required reserves Commissions Annual interest charge
Company A 6% 1.4% 15%
Company B 7% 1.2% 12%
Company C 5% 1.7% 20%
Company D 8% 1.0% 5%

Which company will give Greece the highest proceeds from a P100,000 account due in 60 days?
a. Company A c. Company C
b. Company B d. Company D

7. A company enters into an agreement with a firm that will factor the companys accounts receivable. The factor agrees to
buy the companys receivables, which average P 100,000 per month and have an average collection period of 30 days. The
factor will advance up to 80% of the face value of the receivables at an annual rate of 10% and charge a fee of 2% on all
receivables purchased. The controller of the company estimates that the company would save P 18,000 in collection expenses
over the year. Fees and interest are not deducted in advance.

Assuming a 360-day year, what is the annual cost of financing?

a. 10.0% c. 14.0%
c. 12.0% d. 17.5%

8. Sweden Company, a retail store, is considering foregoing sales discounts in order to delay using its cash. Supplier credit
terms are 2/10, n/30. Assuming a 360-day year, what is the annual cost of credit if the cash discount is not taken and Sweden
pays net 30?
a. 24.0% c. 36.0%
b. 24.5% d. 36.7%

9. Norway Co. buys on terms of 2/10, net/30, but generally does not pay until 40 days after the invoice date. Its purchases
total P 1,080,000 per year. How much non-free trade credit does the firm use each year?
a. P120,000 c. P60,000
b. P90,000 d. P30,000

10. Finland Corporation intends to acquire new equipment costing P 2,400,000. A bank loan can finance the acquisition with
a 10% discounted interest. Alternatively, the company may just delay payment to its suppliers. Presently, the company buys
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. What should the company do?
a. Borrow since it is cheaper by 1.13% than delaying payment to suppliers.
b. Borrow since it is cheaper by 2.5% than delaying payment to suppliers.
c. Delay payments to suppliers since it would cost 12% as against bank loan of 10%
d. Delay payments to suppliers since it does not cost anything.

11. Romania Companys bank requires a compensating balance of 20% on a P 100,000 loan. If that stated interest on the loan
is 7%, what is the effective cost of the loan?
a. 5.83% c. 8.40%
b. 7.00% d. 8.75%

12. Belgium Company got a recent quote on a commercial bank loan of 16% discounted rate with a 20% compensating
balance. The term of the loan is one year. What is the effective cost of borrowing?
a. 19.05% c. 22.85%
b. 20.00% d. 25.00%

13. A bank loans P 1,000,000 to Ireland Industries for 180 days, with interest of P 60,000 to be paid. The bank also requires a
P 200,000 compensating balance for the loan period. What is the effective annual rate?
a. 16.22% c. 14.00%
b. 15.00% d. 13.00%

14. Assume that a bank has lent a firm a P 200,000 for 60 days at 10% interest. The loan is discounted, and the bank requires
a 20% compensating balance. What is the effective annual rate?
a. 14.60% c. 10.17%
b. 12.76% d. 10.00%
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FINANCIAL MANAGEMENT

15. The Brunei Cou-peet Brank and Lugina Corp. signed a loan agreement subject to the following terms
- Stated interest rate of 18% on one-year discounted loan
- 15% compensating non-interest bearing checking account balance to the maintained by Lugina with Brunei Cou-peet
Bank
The net proceeds of the loan totaled P 1,000,000. What was the principal amount of the loan?
a. P 1,492, 537 c. P 1,176,471
b. P1,219,512 d. P 1,000,000

16. Chile Co. obtained a short-term bank loan for P250,000 at an annual interest of 6%. As a condition of the loan, the
company is required to maintain a compensating balance of P 50,000 in its savings account that earns interest at an annual
rate of 2%. The company would otherwise maintain only P 25,000 in the savings account for transaction purposes. What is
the effective interest rate of the loan?
a. 5.80% c. 6.66%
b. 6.44% d. 7.00%

17. A company has accounts payable of P 5 million with terms of 2% discount within 15 days, net 30 days (2/15, n/30)/ It can
borrow funds from a bank at an annual rate of 12% or it can wait until the 30 th day when it will receive revenues to cover the
payment, if it borrows funds on the last day of the discount period in order to obtain the discount, what will be its total cost?
a. P 24,500 more c. P 75,000 less
b. P 51,000 less d. P 100,000 less

18. Brazil Company can issue three-month commercial paper with a face value of P 1,000,000 for P 980,000. The transaction
costs would be P 1,200. What would be the annualized percentage cost of financing?
a. 2.17% c. 8.48%
b. 8.00% d. 8.66%

19. A company has sales last year of P 10 million with net income equal to 6% of sales. This year the sales are expected to be
P 11.2 million. The accounts receivable balance was P 1.5 million at the end of the last year. Using the percentage-of-sales
method, what is the forecasted accounts receivable balance at the end of this year?
a. P 1.572 million c. P 2.172 million
b. P 1.68 million d. P 2.7 million

20. A company has P 500,000 of sales for the year just ended and is projecting sales of P 600,000 for the coming year. For
every P 1 increase in sales, 38% of additional financing is required for the purchase of additional assets. The projected profit
margin is 20% and 60% of profits will be retained for reinvestment in the company. What is the amount of additional external
financing needed by the company in the coming year?
a. P 0 c. P 86,000
b. P 38,000 d. P 110,000

21. Given the following items that vary directly with P 2,000,000 sales for the year 2013.
Assets 65% Liabilities 20%
Net profit margin is 12% and payout ratio is 60% if sales are expected to increase by 25% in 2014, how much is the
additional financing needed?
a. P 225,000 c. P 45,000
b. P 105,000 d. Some other amount

22. A high degree of operating leverage compared with the industry average implies that firm
a. Has higher variable costs
b. Has profits that are more sensitive to changes in sales volume
c. Is more profitable
d. Is less risky

23. For a firm with a degree of operating leverage of 3.5 an increase in sales of 6% will
a. Increase pre-tax profits by 3.5% c. Increase pre-tax profits by 2.1%
b. Decrease pre-tax profits by 3.5% d. Increase pre-tax profits by 1.71%

24. Securing of funds of investment at a fixed rate of return to fund suppliers, to enhance the well being of the common
stockholders is known as
a. Financial leverage c. Prudent borrowing
b. Fund management d. Financial arbitrage
ReSA -The Review School of Accountancy MSQ-11
FINANCIAL MANAGEMENT

25. In 2014, Thailand Corporation increased earnings before interest and taxes by 17%. During the same period, net income
after tax increased by 42%. The degree of financial leverage for 2014 is
a. 1.70 c. 2.47
b. 4.20 d. 5.90
Items 26 to 28 are based on the following information
Vatican Company currently sells 400,000 bottles of perfume each year. Each bottle costs P 0.84 to produce and sells for
P 1.00. Fixed costs are P 28,000 per year. That firm has annual interest expense of P 6,000 preferred stock dividends of P
2,000 per year and a 40% tax rate.

26. What is the degree of operating leverage for Vatican Company?

a. 2.4 c. 1.35
b. 1.78 d. 1.2

27. If Vatican Company did not have preferred stock, the degree of total leverage would
a. Decrease in proportion to a decrease in financial leverage
b. Increase in proportion to an increase in financial leverage
c. Remain the same
d. Decrease but not be proportional to the decrease in financial leverage

28. What is the degree of financial leverage for Vatican Company?

a. 2.4 c. 1.25
b. 1.50 d. 1.20

29. A company has unit sales of 300,000 unit variable cost of P 1.50, unit sales price of P 2.00 and annual fixed costs of
P 50,000. Furthermore, the annual interest expense if P 20,000 and the company has no preferred stock. Accordingly, what is
the degree of combined leverage?
a. 1.875 c. 1.25
b. 1.50 d. 1.20

30. The theory underlying the cost of capital is primarily concerned with the cost of
a. Long-term funds and old funds c. Long-term funds and new funds
b. Short-term funds and new funds d. Short-term funds and old funds

31. All of the following are good sources of financing for permanent working capital except
a. A bank line of credit c. Preference share
b. Retained earnings d. Ordinary share

32. If a P 1,000 bond sells for 105, which of the following statements is correct?
a. The bond sells at a discount
b. The coupon rate on the bond and the market rate of interest are equal
c. The coupon rate on the bond is greater than the market rate of interest
d. The market rate of interest is greater than the coupon rate on the bond

33. If Laos Companys bonds are currently yielding 8% in the marketplace, why is the firms cost of debt lower?
a. Market interest rates have increased
b. Additional debt can be issued more cheaply than the original debt
c. There should be no difference, cost of debt is the same as the bonds market yield
d. Interest is deductible for tax purposes

34. Malaysia Companys preferred stock that bears 10% dividend rate and has a par value of P 100 per share is sold for
P 101, gross of underwriting fees of P 5 per share. If the tax rate is 40%, what is the cost of funds for preferred stock?
a. 4.2% c. 10.0%
b. 6.2% d. 10.4%

35. The term underwriting spread refers to the

a. Commission percentage an investment banker receives for underwriting a security issue
b. Discount investment bankers receive on securities they purchase from the issuing company
c. Difference between the price the investment banker pays for a new security issue and the price at which
the securities are resold
d. Commission a broker receives for either buying or selling a security on behalf of an investor
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FINANCIAL MANAGEMENT

36. Taiwan Corporation is preparing to issue preferred stock. The preferred stock will have a P 100 par value and will P8 per
year in dividends. Flotation costs for the new issue will be P 2.38 per share. Taiwans marginal tax rate is 34%. The issue
price is expected to be P 96.50 per share. Based on this information, what is Taiwan Corporations cost of preferred stock?
a. 5.3% c. 5.6%
b. 8.5% d. 8.0%

37. The three elements needed to estimate the cost of equity capital for use in determining a firms weighted average cost of
capital are
a. Current dividends per share, expected growth rate in dividends per share and current book value per
share of common stock
b. Expected earnings per share, expected growth rate in dividends per share, and current market once per
share ofcommon stock
c. Current earnings per share, expected growth rate in earnings per share and current book value per share
of common stock
d. Expected dividends per share, expected growth rate in dividends per share the current market price per
share of common stock

38. The investment-banking firm of Syria & Associates will use a dividend valuation model to appraise the shares of the
Lebanon Corporation. Dividends (D ) at the end of the current year will be P1.20 the growth rate (g) is 9 percent and the
discount rate (K) is 13 per cent. What should be the price of the stock to the public?
a. P 28.75 c. P 30.00
b. P 29.00 d. P 31.50

39. Ceteris paribus, the market value of a firms outstanding common shares will be higher if
a. Investors have a lower required return on equity
b. Investors expect lower dividend growth
c. Investors have longer expected holding periods
d. Investors have shorter expected holding periods

40. The France Co. paid cash dividends to its common stockholders over the past 12 months at P 2.20 per share. The current
market value of the common stocks is P 40 per share, and investors are anticipating the common dividends to grow at a rate
of 6% annually. The cost to issue new common stocks will be 5% of the market value. What will be the cost of the new
common stock issue?
a. 11.50% c. 11.83%
b. 11.79% d. 12.14%

41. In general, it is more expensive for a company to finance with equity capital than with debt capital because
a. Long-term bonds have a maturity date and must therefore be repaid in the future
b. Investors are exposed to greater risk with equity capital
c. Equity capital is in greater demand than debt capital
d. Dividends fluctuate to a greater extent than interest rates

Items 42 to 47 are based on the following information

The England Corporation is preparing to evaluate capital expenditure proposals for the coming year because the firm employs
discounted cash flow methods, the cost of capital for the firm must be estimated. The following information for England
Corporation is provided.
- The Market price of common stock is 60 per share
- The dividend next year is expected to be P 3 per share
- Expected growth in dividends is a constant 10%
- New bonds can be issued at face value with a 10% coupon rate
- The current capital structure of 40% long-term debt and 60% equity is considered to be optimal
- Anticipated earnings to be retained in the coming year are P 3 million
- The firm has a 40% marginal tax rate

42. What is the after-tax cost of the new bond issue?

a. 4% c. 10%
b. 6% d. 14%

43. What is the cost of using retained earnings for financing?

a. 5% c. 10%
b. 9% d. 15%
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FINANCIAL MANAGEMENT

44. If the company assume a 20% flotation cost on new stock issuancesm what is the cost of new common stock?
a. 6.25% c. 15%
b. 10% d. 16.25%

45. What is the maximum capital expansion that can be supported in the coming year without resorting to external equity
financing?
a. P 2 million c. P 5 million
b. P 3million d. Cannot be determined from information given

46. Assume that the after-tax cost of debt financing is 10%, the cost of retained earnings is 14% and the cost of new common
stock is 16%. If capital expansion needs to be P 7 million for the coming year, what is the after-tax weighted-average cost of
capital?
a. 11.14% c. 13.60%
b. 12.74% d. 16.00%

47. Assume that the after-tax cost of debt financing is 10%, the cost of retained earnings is 14% and the cost of new common
stock is 16%. What is the marginal cost of capital for any projected capital expansion in excess of P 7 million
a. 10.00% c. 13.60%
b. 12.74% d. 16.00%

48. When calculating the cost of capital, what should be the cost assigned to retained earnings?
a. Zero
b. Lower than the cost of external common equity
c. Equal to the cost of external common equity
d. Higher than the cost of external common equity

49. Using the Capital Asset Pricing Model (CAPM) approach of computing the cost of common equity retained earnings,
which among the following formulas is correctly stated?
KRF -> Risk-free rate
KM -> Expected rate of return on the market/average stock
B - > Stocks beta coefficient (index of stocks risk)
a. KRF + (KM)B c. KRF + (KM - KRF )B
b. (KRF + KM)B d. (KM - KRF)B

50. Using Capital Asset Pricing Model (CAPM), the required rate of return for a firm with a beta of 1.25 when the market
rate is 14% and the risk-free rate is 6% is
a. 6% c. 14%
b. 7.5% d. 16%

51. The difference between the required rate of return on a given risky investment and that in a risk-free investment with the
same expected return is the
a. Risk premium c. Standard deviation
b. Coefficient of variation d. Beta coefficient

52. A measure that descrives the risk of an investment project relative to other investments is general is the
a. Coefficient of variation c. Standard deviation
b. Beta Coefficient d. Expected return

53. Tibet Inc. is planning to use retained earnings to finance anticipated capital expenditures. The beta coefficient for Tibet
stocks is 1.15, the risk-free rate of interest is 8.5% and the market return is estimated to be a 12.4 percent. If a new issue of
common sotck was used in this model, the flotation costs would be 7 percent. By using Capital Asset Pricing Model equation,
The cost of using retained earnings to finance the capital expenditures is
a. 12.40% c. 13.96%
b. 12.99% d. 14.26%

54. A company has P 1,000,000 in shareholders equity and P 2,000,000 in debt equity (8% bonds) Its after-tax weighted
average cost of capital is 12%, but it uses 15% as the hurdle rate in capital budgeting decisions. During the past year, its
operating income before tax and interest was P 500,000. Its tax rate is 40%. What is the companys cost of equity capital?
a. 8% c. 15%
b. 12% d. 26.4%
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FINANCIAL MANAGEMENT

Items 54 to 56 are based on the following information

Saudi Telecom is considering a project for the coming year that will cost P 50 million. Saudi plans to use the following
combination of debt and equity to finance the investment
- Issue P 15 million of 20-year bonds at a price of 101, with a coupon rate of 8%, and flotation costs of 2% of face amount.
- Use P 35million of funds generated from earnings
- The equity market is expected to earn 12%. Treasury bonds are currently yielding 5%. The beta coefficient for Saudi is
estimated to be 0.60, Saudi is subject to an effective corporate income tax rate of 40%

54. The before-tax cost of Saudis planned debt net of flotation costs in the first tear is
a. 11.80% c. 8.08%
b. 10.00% d. 7.92%

55. Assume that the after-tax cost of debt is 7% and the cost of equity is 12%. What is the weighted average cost of capital
(WACC)?
a. 10.50% c. 8.50%
b. 9.50% d. 6.30%

56. The capital asset pricing model (CAPM) computes the expected return on a security by adding the risk-free rate of return
to the incremental yield of the expected market return, which is adjusted by the companys beta. Compute Saudis expected
rate of return.
a. 12.20% c. 9.20%
b. 12.00% d. 7.20%

Items 57 to 60 are based on the following information

Spain, Inc is interested in measuring its overall cost of capital and has gathered the following data. Under the terms described
below, the company can sell unlimited amounts of all instruments.
- Spain can raise cash by selling P 1,000. 8% 20-year bonds with annual interest payments. In selling the issue, an
average premium of P 30 per bond would be received, and the firm must pay flotation costs of P 30 per bond. The
after-tax cost of funds is estimated to be 4.8%
- Spain can sell 8% preferred stock at P 105 per share. The cost of issuing and selling the preferred stock is expected
to be P5 per share
- Spains common stock is currently selling for P 100 per share. The firm expects to pay next year cash dividends of
P 7 per share, and the dividends are expected to remain constant. The stock will have to be under-priced by P3 per
share, and flotation costs are expected to amount to P 5 per share.
- Spain expects to have available P 100,000 of retained earnings in the coming year once these retained earnings
are exhausted the firm will use new common stock as the form of common stock equity financing.
- Spains preferred capital structure is Long-term debt 30%. Preferred stock 20% and Common stock 50%

57. The cost of funds from sale of common stock from Spain, Inc is
a. 7.0% c. 7.6%
b. 7.4% d. 8.1%

58. The cost of funds from retained earnings for Spain, Inc is
a. 7.0% c. 7.6%
b. 7.4% d. 8.1%

59. If Spain, Inc needs a total of P 200,000, the firms weighted average cost of capital would be
a. 4.8% c. 6.8%
b. 6.5% d. 19.80%
SOLUTION 4.8%(30%) + 8.0% (20%) + 7.0% (50%)

60. If Spain, Inc. needs a total of P 1,000,000 the firms weighted average cost of capital would be
a. 4.8% c. 6.8%
b. 6.5% d. 19.80%
SOLUTION 4.8% (30%)+ 8.0% (20%) + 7.6% ( 40%) + 7.0% (10%)