Activity 4

Financial Management – current assets and current liabilities

Instructions. Choose the BEST answer for each of the following items.

Working Capital
1. Which one of the following transactions would increase the current ratio and decrease net profit?
a. An income tax payment due from the previous year is paid
b. A stock dividend is declared
c. Uncollectible accounts receivable are written off against the allowance account
d. Vacant land is sold for less than the net book value
2. The working capital financing policy that subjects the firm to the greatest risk of being unable to meet the firm’s maturing obligations is the
policy that finances
a. Fluctuating current assets with long-term debt. c. Permanent current assets with short-term debt.
b. Permanent current assets with long-term debt. d. Fluctuating current assets with short-term debt.
3. The working capital financing policy that subjects the firm to the greatest risk of being unable to meet the firm’s maturing obligations is the
policy that finances (where: CA = current assets)
a. Temporary CA with long-term debts c. Permanent CA with long-term debts
b. Fluctuating CA with short-term debts d. Permanent CA with short-term debts
4. Which of the following actions would not be consistent with good working capital management?
a. Increased synchronization of cash flows
b. Minimize the use of float
c. Maintaining an average cash balance equal to that which minimizes total cost
d. Use of checks and drafts in disbursing funds
5. A compensating balance
a. Compensates a financial institution for services rendered by providing it with fund deposits
b. Is used to compensate for possible losses on a marketable securities portfolio
c. Is a level of inventory held to compensate for variations in usage rate and lead time
d. Is the amount of prepaid interest on a loan
6. The average collection period for a firm measures the number of days
a. After a typical credit sale is made until the firm receives the payment
b. For a typical check to clear through the banking system
c. Beyond the end of the credit period before a typical customer payment is received
d. Before a typical account becomes delinquent
7. Other things held constant, which of the following will cause an increase in net working capital?
a. Cash is used to buy marketable securities.
b. A cash dividend is declared and paid.
c. Merchandise is sold at a profit, but the sale is on credit.
d. Long-term bonds are retired with the proceeds of a preferred stock issue.
e. Missing inventory is written off against retained earnings.
8. Firms generally choose to finance temporary current operating assets with short-term debt because
a. matching the maturities of assets and liabilities reduces risk under some circumstances, and also because short-term debt is often less
expensive than long-term capital.
b. short-term interest rates have traditionally been more stable than long-term interest rates.
c. a firm that borrows heavily on a long-term basis is more apt to be unable to repay the debt than a firm that borrows short term.
d. the yield curve is normally downward sloping.
e. short-term debt has a higher cost than equity capital
9. Helena Furnishings wants to reduce its cash conversion cycle. Which of the following actions should it take?
a. Increase average inventory without increasing sales.
b. Take steps to reduce the DSO.
c. Start paying its bills sooner, which would reduce the average accounts payable but not affect sales.
d. Sell common stock to retire long-term bonds.
e. Sell an issue of long-term bonds and use the proceeds to buy back some of its common stock.
10. Which of the following statements is CORRECT?
a. Net working capital is defined as current assets minus the sum of payables and accruals, and any increase in the current ratio
automatically indicates that net working capital has increased.
b. Although short-term interest rates have historically averaged less than long-term rates, the heavy use of short-term debt is considered
to be an aggressive strategy because of the inherent risks associated with using short-term financing.
c. If a company follows a policy of "matching maturities," this means that it matches its use of common stock with its use of long-term
debt as opposed to short-term debt.
d. Net working capital is defined as current assets minus the sum of payables and accruals, and any decrease in the current ratio
automatically indicates that net working capital has decreased.
e. If a company follows a policy of "matching maturities," this means that it matches its use of short-term debt with its use of long-term
debt.
11. Other things held constant, which of the following would tend to reduce the cash conversion cycle?
a. Carry a constant amount of receivables as sales decline.
b. Place larger orders for raw materials to take advantage of price breaks.
c. Take all discounts that are offered.
d. Continue to take all discounts that are offered and pay on the net date.
 e. Offer longer payment terms to customers.
12. Which of the following statements concerning the cash budget is CORRECT?
a. Depreciation expense is not explicitly included, but depreciation's effects are reflected in the estimated tax payments.
b. Cash budgets do not include financial items such as interest and dividend payments.
c. Cash budgets do not include cash inflows from long-term sources such as the issuance of bonds.
d. Changes that affect the DSO do not affect the cash budget.
e. Capital budgeting decisions have no effect on the cash budget until projects go into operation and start producing revenues.
13. Which of the following statements is NOT CORRECT?
a. Commercial paper can be issued by virtually any firm so long as it is willing to pay the going interest rate.
b. Accruals are "free" in the sense that no explicit interest is paid on these funds.
c. A conservative approach to working capital management will result in most if not all permanent current operating assets being financed
with long-term capital.
d. The risk to a firm that borrows with short-term credit is usually greater than if it borrowed using long-term debt. This added risk stems
from the greater variability of interest costs on short-term debt and possible difficulties with rolling over short-term debt.
e. Bank loans generally carry a higher interest rate than commercial paper.
14. Which of the following statements is NOT CORRECT?
a. A company may hold a relatively large amount of cash and marketable securities if it is uncertain about its volume of sales, profits, and
cash flows during the coming year.
b. Credit policy has an impact on working capital because it influences both sales and the time before receivables are collected.
c. The cash budget is useful to help estimate future financing needs, especially the need for short-term working capital loans.
d. If a firm wants to generate more cash flow from operations in the next month or two, it could change its credit policy from 2/10 net 30
to net 60.
e. Managing working capital is important because it influences financing decisions and the firm's profitability.
15. USA Co. has an acid test ratio of 1.5 to 1.0. Which of the following will cause this ratio to deteriorate?
a. Payment of cash dividends previously declared c. Sale of inventory on account
b. Borrowing short-term loan from a bank d. Sale of equipment at a loss

Problems
16. A firm’s current ratio is currently 2.2 to 1. Management knows it cannot violate a working capital restriction contained in its bond indenture. If
the firm’s current ratio falls below 2 to 1, technically it will have defaulted. If current liabilities are P200,000,000, what is the maximum new
commercial paper that can be issued to finance inventory expansion?
a. P 20 million b. P 40 million c. P 180 million d. P 240 million
17. Australia Corporation has 100,000 shares stock outstanding. Below is part of Australia’s Statement of Financial Position for the last fiscal year
AUSTRALIA Corporation
Statement of Financial Position as of December 31 – Selected items
Cash P 455,000
Accounts receivable 900,000
Inventory 650,000
Prepaid assets 45,000
Accrued liabilities 285,000
Accounts payable 550,000
Current portion, long-term notes payable 65,000
What is the maximum amount Australia can pay in cash dividends per share and maintain current ratio of 2 to 1? Assume that all accounts
other than cash remain unchanged.
a. P 2.05 b. P 2.50 c. P 3.35 d. P 3.80
18. Asia Inc. has a pool of cash that it uses to pay bills. When the cash is exhausted, it replenishes its pool by selling t-bills. The firm disburses P
600,000 in cash every year, and every sale of t-bills costs P 60. The current risk-free rate is 8%. What is the optimal cash balance for Asia?
a. P 27,932 b. P 48,530 c. P 30,000 d. P 37,546
19. Data on Shick Inc. for 2020 are shown below, along with the days sales outstanding of the firms against which it benchmarks. The firm's new
CFO believes that the company could reduce its receivables enough to reduce its DSO to the benchmarks’ average. If this were done, by how
much would receivables decline? Use a 365-day year.

Sales P110,000
Accounts receivable P16,000
Days sales outstanding (DSO) 53.09
Benchmark days sales outstanding (DSO) 20.00

a. P 8,078 b. P 8,975 c. P 9,973 d. P10,970 e. P12,067

20. A firm averages P4,000 in sales per day and is paid on an average, within 30 days of the sale. After they receive their invoice, 55% of the
customers pay in cash while the remaining 45% pay by credit card. Approximately how much would the company have in accounts receivable on
its balance sheet on a given date?
a. P4,000 b. P120,000 c. P48,000 d. P54,000
21. A firm sells on terms of 2/10 net 60. It sells 1,000 units per day at a unit price of P10. On 60% of sales, customers take the cash discount. On the
remaining 40% of sales, customers pay, on average, in 70 days. What would be the impact on the balance of accounts receivable if the firm
initiates a more aggressive collection policy and is able to reduce the average payment period to 60 days for those customers not taking the cash
discount? (Assume sales levels are unaffected by the change in policy.)
A. Decrease by P4,000. B. Decrease by P40,000. C. Decrease by P240,000. D. Decrease by P280,000.
22. A company sells 10,000 skateboards a year at P66 each. All sales are on credit, with terms of 3/10, net 30, which means three percent discount if
payment is made within 10 days; otherwise full payment is due at the end of 30 days. One half of the customers are expected to take advantage
of the discount and pay on day 10. The other half are expected to pay on day 30. Sales are expected to be uniform throughout the year for both
types of customers. What is the expected average collection period for the company?
 A. 10 days. B. 15 days. C. 20 days. D. 30 days

Inventory
23. Which of the following statements is most consistent with efficient inventory management? The firm has a
a. below average inventory turnover ratio.
b. low incidence of production schedule disruptions.
c. below average total assets turnover ratio.
d. relatively high current ratio.
e. relatively low DSO.
Receivables
24. Which of the following statements is CORRECT?
a. A firm that makes 90% of its sales on credit and 10% for cash is growing at a constant rate of 10% annually. Such a firm will be able to keep
its accounts receivable at the current level, since the 10% cash sales can be used to finance the 10% growth rate.
b. In managing a firm's accounts receivable, it is possible to increase credit sales per day yet still keep accounts receivable fairly steady,
provided the firm can shorten the length of its collection period (its DSO) sufficiently.
c. Because of the costs of granting credit, it is not possible for credit sales to be more profitable than cash sales.
d. Since receivables and payables both result from sales transactions, a firm with a high receivables-to-sales ratio must also have a high
payables-to-sales ratio.
e. Other things held constant, if a firm can shorten its DSO, this will lead to a higher current ratio.
25. A firm averages P4,000 in sales per day and is paid on an average, within 30 days of the sale. After they receive their invoice, 55% of the
customers pay in cash while the remaining 45% pay by credit card. Approximately how much would the company have in accounts receivable on
its balance sheet on a given date?
a. P4,000 b. P120,000 c. P48,000 d. P54,000
26. A company plans to tighten its credit policy. The new policy will decrease the average number of days for collection from 75 to 50 days and will
reduce the ratio of credit sales to total revenue from 70% to 60%. The company estimates that projected sales will be 5% less if the proposed
new credit policy is implemented. If projected sales for the coming year are P50 million, calculate the peso amount of accounts receivable of this
proposed change in credit policy. Assume a 360-day year.
a. P3,817,445 decrease. b. P6,500,000 decrease. c. P3,333,334 decrease. d. P18,749,778 increase.
Marketable Securities
27. Which of the following statements is CORRECT?
a. A firm that makes 90% of its sales on credit and 10% for cash is growing at a constant rate of 10% annually. Such a firm will be able to keep
its accounts receivable at the current level, since the 10% cash sales can be used to finance the 10% growth rate.
b. In managing a firm's accounts receivable, it is possible to increase credit sales per day yet still keep accounts receivable fairly steady,
provided the firm can shorten the length of its collection period (its DSO) sufficiently.
c. Because of the costs of granting credit, it is not possible for credit sales to be more profitable than cash sales.
d. Since receivables and payables both result from sales transactions, a firm with a high receivables-to-sales ratio must also have a high
payables-to-sales ratio.
e. Other things held constant, if a firm can shorten its DSO, this will lead to a higher current ratio.
28. Hendrix, Inc. is interested in purchasing a P100 Treasury bill and was presented with the following options:

Due Date Discount Rate

Option 1 180 days 6%
Option 2 360 days 3.5%
Option 3 120 days 8%
Option 4 240 days 4.5%
If Hendrix wishes to buy the Treasury bill at the lowest purchasing price, which option should be chosen, assuming a 360-day year?
A. Option 1. B. Option 2. C. Option 3. D. Option 4.
Payables deferral period
29. Data on Wentz Inc. for 2020 are shown below, along with the payables deferral period (PDP) for the firms against which it benchmarks. The
firm's new CFO believes that the company could delay payments enough to increase its PDP to the benchmarks’ average. If this were done, by
how much would payables increase? Use a 365-day year.
Cost of goods sold = P75,000
Payables = P5,000
Payables deferral period (PDP) = 24.33
Benchmark payables deferral period = 30.00

a. P 764 b. P 849 c. P 943 d. P1,048 e. P1,164

30. Affleck Inc.'s business is booming, and it needs to raise more capital. The company purchases supplies on terms of 1/10 net 20, and it currently
takes the discount. One way of getting the needed funds would be to forgo the discount, and the firm's owner believes she could delay
payment to 40 days without adverse effects. What would be the effective annual percentage cost of funds raised by this action? (Assume a
365-day year.)

a. 10.59% b. 11.15% c. 11.74% d. 12.36% e. 13.01%

31. Aggarwal Inc. buys on terms of 2/10 net 30, and it always pays on the 30th day. The CFO calculates that the average amount of costly trade
credit carried is P375,000. What is the firm's average accounts payable balance? Assume a 365-day year.

a. P458,160 b. P482,273 c. P507,656 d. P534,375 e. P562,500

32. Phranklin Pharms Inc. purchases merchandise from a company that gives sales terms of 2/15, net 40. Phranklin Pharms has gross purchases of
P800,000 per year. What is the maximum amount of costly trade credit Phranklin could get, assuming they abide by the suppliers credit terms?
(Assume a 360-day year.)
 a. P87,111.20 c. P54,444.50
b. P32,666.70 d. P52,266.67
33. Your firm buys on credit terms of 2/10, net 45, and it always pays on Day 45. If you calculate that this policy effectively costs your firm P157,500
each year, what is the firm’s average accounts payable balance?
a. P1,234,000 b. P75,000 c. P625,000 d.P750,000
34. 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 dollar savings over the year by borrowing and then taking
the discount on the materials?
A. P3,624 B. P1,176 C. P4,800 D. P1,224
35. Improvements to cash management include all of the following EXCEPT a reduction in
a. the cash turnover. c. the average age of inventory.
b. the cash conversion cycle. d. the average collection period
.
36. 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. 05,000 gallons.