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GENERAL WORKING CAPITAL MANAGEMENT

Caysasay Corporation found out the following working capital balances in its last 12 months of
operations:

Cash
Accounts Receivable
Inventory
Accounts Payable

Lowest
100,000
300,000
250,000
400,000

Highest
180,000
500,000
400,000
600,000

1. How much is the permanent current asset balance?


a. 500,000
c. 600,000
b. 650,000
d. 750,000
2. How much is the temporary current assets balance?
a. 400,000
c. 420,000
b. 410,000
d. 430,000
3. What is the balance for the average current assets?
a. 435,000
c. 450,000
b. 440,000
d. 500,000
4. How much is the balance for permanent working capital?
a. 300,000
c. 450,000
b. 350,000
d. 250,000
5. How much is the average working capital?
a. 100,000
c. 150,000
b. 125,000
d. 175,000
6. During the year, Hechanova Companys current assets increased by P130, current
liabilities decreased by P60, and net working capital
a. Increased by P70
c. decreased by P190
b. Did not change
d. increased by P190
7. Lacaran Corporation has 100,000 shares of stock outstanding. Below is part of
Lacarans Statement of Financial Position for the last fiscal year.
Lacaran Corporation
Statement of Financial Position Selected Items
December 31, 2015
Cash
Accounts receivable
Inventory
Prepaid assets
Accrued liabilities
Accounts payable

455,000
900,000
650,000
45,000
285,000
550,000

Current portion of long-term notes payable

65,000

What is the maximum amount Lacaran can pay in cash dividends per share and maintain a
minimum current ratio of 2 to 1? Assume that all accounts other than cash remain unchanged.
a. 2.05
c. 3.35
b. 2.50
d. 3.80
Seminarian Airlines is deciding whether to pursue a restricted or relaxed working capital
investment policy. Seminarians annual sales are expected to total P3.6 million, its fixed assets
turnover ratio equals 4.0, and its debt and common equity are each 50 percent of total assets.
EBIT is P150,000, the interest rate on the firms debt is 10 percent, and the firms tax rate is 40
percent. If the company follows a restricted policy, its total assets turnover will be 2.5.
Under a relaxed policy, its total assets turnover will be 2.2.
8. If the firm adopts a restricted policy, how much will it save in interest expense (relative to
what it would be if Seminarian were to adopt a relaxed policy)?
a. P3,233
c. P9,818
b. P6,175
d. P7,200
9. What is the difference in the projected ROEs between the restricted and relaxed
policies?
a. 2.24%
c. 1.00%
b. 1.50%
d. 0.50%
10. Assume now the company expects that if it adopts a restricted policy, its sales will fall by
15 percent, EBIT will fall by 10 percent, but its total assets turnover, debt ratio, interest
rate, and tax rate will remain the same. In this situation, what is the difference in the
projected ROEs between the restricted and relaxed policies?
a. 2.24%
c. 1.00%
b. 1.50%
d. 0.50%
11. The Working Capital of Sun Company at December 31, 2012 was P10,000,000.
Selected information for the year 2013 for Sun Company is as follows:
Working capital provided from operations
Capital expenditure
Proceeds from short-term borrowings
Proceeds from long-term borrowings
Payments of short-term borrowings
Payments of long-term borrowings
Proceeds from issuance of common stock
Dividends paid on common stock
What is Suns working capital on December 31, 2013?
a. 11,200,000
c. 10,700,000
b. 11,500,000
d. 12,000,000

1,700,000
3,000,000
1,000,000
2,000,000
500,000
600,000
1,400,000
800,000

12. Bukas Palad Companys budgeted sales and budgeted cost of sales for the coming year
are P212,000,000 and P132,500,000, respectively. Short-term interest rates are
expected to average 5%. If Bukas Palad could increase inventory turnover from its
current 8.0 times per year to 10.0 times per year, its expected cost savings in the current
year would be
a. 165,625
c. 3,312,500
b. 0
d. 828,125
13. The management of Dominic Company does not want to violate a working capital
restriction contained in its bond indenture. If the firms current ratio is now 2.0 to 1,
technically it will have defaulted. The firms current ratio is now 2.2 to 1. If the current
liabilities are P200 million, the maximum new commercial paper that can be issued to
finance inventory expansion is
a. 20 million
c. 240 million
b. 40 million
d. 180 million
14. A companys policy is to maintain a current ratio of at least 2:1. At present, its current
ratio is 2.5 is to 1. If current liabilities at present amount to P250,000, what is the
maximum amount of short-term commercial loan that can be obtained by the firm to
finance inventory expansion without violating the current ratio policy?
a. 125,000
c. 62,500
b. 0
d. 50,000
15. A company received a line of credit from its bank. The stated interest rate is 12%,
deducted in advance. The line of credit agreement requires that an amount equal to 20%
of the loan be deposited into a compensating balance account. On March 1, the
company drew down the entire usable amount of the loan and received the proceeds of
P340,000. How much is the principal amount of the loan?
a. 340,000
c. 231,200
b. 500,000
d. 448,800
16. Other things held constant, which of the following will cause an increase in 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.
17. Firms generally choose to finance temporary net operating working capital with shortterm debt because
a. Matching the maturities of assets and liabilities reduces risk.
b. Short-term interest rates have traditionally been more stable than long-term interest
rates.

c. A firm that borrows heavily long-term is more apt to be unable to repay the debt than a
firm that borrows heavily short-term.
d. The yield curve has traditionally been downward sloping.
18. 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
19. 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.
20. All of the following statements about working capital are correct except:
a. Current liabilities are and important source of financing for many small firms.
b. Profitability varies inversely with liquidity.
c. The hedging approach to financing involves matching maturities of debt with specific
financing needs.
d. Financing permanent inventory buildup with long term debt is an example of an
aggressive working capital policy.
21. 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 given choices
22. When a firm finances long-term assets with short-term sources of funding it
a. Reduces the risk of cash shortage
b. Will have higher interest expense
c. Improves leverage ratio
d. Is ignoring the principle of matched securities
23. 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
24. S1: Net working capital may be defined as current assets minus current liabilities. This
also defines the current ratio.
S2: Net working capital is defined as current assets divided by current liabilities.
a. Only S1 is correct
b. Only S2 is correct

c. Both statements are correct


d. Both statements are false
25. S1: An increase in a current asset account must be accompanied by a corresponding
increase in a liability account.
S2: Determination of a firm's investment in net operating working capital and how that
investment is financed are elements of working capital policy.
a. Only S1 is correct
b. Only S2 is correct
c. Both statements are correct
d. Both statements are false
26. S1: 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 working capital
financing strategy because of the inherent risks of using short-term financing.
S2: A conservative financing approach to working capital will result in all permanent net
operating working capital being financed using long-term securities.
a. Only S1 is correct
b. Only S2 is correct
c. Both statements are correct
d. Both statements are false
27. S1: A firm adopting an aggressive working capital financing approach is more sensitive
to unexpected changes in the term structure of interest rates than is a firm with a
conservative financing policy.
S2: A firm that employs an aggressive working capital financing policy stands to increase
profitability when the yield curve changes from upward sloping to downward sloping.
a. Only S1 is correct
b. Only S2 is correct
c. Both statements are correct
d. Both statements are false
28. S1: The risk to the firm of borrowing using short-term credit is usually greater than with
long-term debt. Added risk stems from greater variability of interest costs on short-term
debt. Even if its long-term prospects are good, the firm's lender may not renew a shortterm loan if the firm is even only temporarily unable to repay it.
S2: Long-term loan agreements always contain provisions, or covenants, which
constrain the firm's future actions. Short-term credit agreements are just as restrictive in
order to protect the interests of the lender.
a. Only S1 is correct
b. Only S2 is correct
c. Both statements are correct
d. Both statements are false
29. S1: A firm constructing a new manufacturing plant and financing it with short-term loans
that are scheduled to be converted to first mortgage bonds when the plant is completed,

would want to separate the construction loan from other current liabilities associated with
working capital management.
S2: Permanent net operating working capital reflects the fact that net operating working
capital does not shrink to zero even when business is at a seasonal or cyclical low.
Thus, permanent net operating working capital represents a minimum level of net
operating working capital the firm must finance.
a. Only S1 is correct
b. Only S2 is correct
c. Both statements are correct
d. Both statements are false
30. The fundamental analysis of cash flow generated from operations may be determined
using any of the following except:
a. After-tax income plus depreciation
b. Profit less depreciation plus taxes
c. Profit plus depreciation
d. Cash sales less cash operating costs less taxes paid.
31. Which of the following is not a use of working capital?
a. Repurchase of common stock
b. Purchase of inventory on account
c. Purchase of equipment on account
d. Repayment of long-term debt
32. Compared to other firms in the industry, a company that maintains a conservative
working capital policy will tend to have a
a. Greater percentage of short-term financing
b. Greater risk of needing to sell current assets to repay debt
c. Higher ratio of current assets to fixed assets
d. Higher total asset turnover
33. Which of the following account changes would be classified as use of funds?
a. An increase in accounts payable
b. An increase in retained earnings
c. A decrease in bonds payable
d. A decrease in accounts receivable
34. Which of the following would reduce the additional funds required if all other things are
held constant?
a. A decrease in the companys tax rate
b. An increase in the expected sales growth rate
c. An increase in the dividend payout ratio
d. A decrease in the profit margin
35. Which one of the following transactions does not change the current ratio and does not
change the total current assets?
a. A cash advance is made to a divisional office
b. A cash dividend is declared

c. Short-term notes payables are retired with cash


d. A fully depreciated asset is sold for cash

SOLUTIONS
1.
Cash
Accounts Receivable
Inventory
Permanent current assets

100,000
300,000
250,000
650,000

2.
Max. Current Assets
Min. Current Assets
Temporary Current Assets

1,080,000
(650,000)
430,000

3.
Permanent Current Assets
Ave. Temporary current assets
Ave. Current Assets

650,000
(215,000)
435,000

4.
Permanent Current Assets
Permanent current liabilities
Permanent net working capital

650,000
(400,000)
250,000

5. 250,000/2 = 125,000
6.
Increase in assets
Decrease in liabilities
net working capital
7.
Old current assets
Maintained current assets
Allowed reduction for cash dividends
Dividend per share

130
60
190

2,050,000
1,800,000
250,000
P2.50

8.
Step 1:

Calculate net fixed assets, which will be the same under either policy.

FA turnover =

S
NFA

P3,600,000
NFA
4.0 =

NFA = P900,000.
Step 2:
Determine total assets under each policy, given the total assets turnover ratio
for each one.
Restricted: Total assets turnover =

S
TA

P3,600,000
TA
2.5 =
TA = $\P1,440,000.
$3,600,000
TA

Relaxed: 2.2 =
TA = $1,636,364.
Step 3:

Develop balance sheets for each policy to determine the debt level.
Restricted
Relaxed
Current assets
P540,000
P736,364
Fixed assets
900,000
900,000
Total assets
P1,440,000
P1,636,364
Debt
P720,000
P 818,182
Equity
720,000
818,182
Total liabilities & equity P1,440,000
P1,636,364
Step 4:
Determine interest under each policy:
Restricted: P720,000 0.10 = P72,000.
Relaxed: P818,182 0.10 = P81,818.
Step 5:
Calculate the difference in interest expense (the savings) between the 2
policies:
P81,818 - P72,000 = P9,818.
9.
Step 1:
policy.

From the previous problem we can now set up an income statement for each

EBIT
Interest (10%)
EBT
Taxes
Net income

Restricted
Relaxed
P150,000
P150,000
72,000
81,818
P78,000
P68,182
31,200
27,273
P46,800
P40,909

Step 2:
Calculate ROE using common equity as calculated in the prior problem for
each policy.

P 46,800
P720,000
Restricted: ROE =
= 6.5%.

P 40,909
P818,182
Relaxed: ROE =
= 5.0%.

Step 3:
Calculate the difference in ROEs.
ROE = 6.5% - 5.0% = 1.5%.
10.
From the prior two problems, we know that the ROE for the relaxed policy is 5%. Now,
we need to calculate the new ROE under the restricted policy.
Step 1:
Calculate the new sales and EBIT levels.
New sales = P3,600,000 0.85 = P3,060,000.
New EBIT = P150,000 0.90 = P135,000.
Step 2:
Calculate the new level of assets under the restricted policy.
S/TA = 2.5
P3,060,000/2.5 = P1,224,000.
Step 3:

Develop the firms balance sheet under the restricted policy.

Total assets

P1,224,000

Debt
P 612,000
Equity
612,000
Total liabilities & equity P1,224,000
Step 4:

Develop the firms income statement under the restricted policy.

EBIT
P135,000
Interest (10%) 61,200
EBT
P73,800
Taxes (40%)
29,520
Net income
P 44,280
Step 5:
Calculate the firms ROE under the restricted policy.
ROE = NI/E = P44,280/P612,000
ROE = 7.24%.
Step 6:
Calculate the difference in ROEs between the 2 policies.
ROE = 7.24% - 5% = 2.24%
11.
WC 12/31/15
Sources of 2015 WC
From operations
From long-term borrowings
From issuance of common stock

10,000,000
1,700,000
2,000,000
1,400,000
(3,000,000)

Uses of 2015 WC
Capital expeditures
Payments on long-term borrowings
Dividends paid
WC 12/31/16

(3,000,000)
(600,000)
(800,000)
10,700,000

12. The inventory turnover is expected to increase from 8 times to 10 times. This would
result to a decrease in inventory balance, as follows:
Before
After
Cost of goods sold
132,500,000 132,500,000
Inventory turnovers
8 times
10 times
Inventory balances
16,562,500
13,250,000
Decrease in inventory
3,312,500
Cost savings
165,625
13. (440 million + X) / (200 million + X) =2.0
440 million + X = 400 million + 2X
X= 40 million
14. 2(250,000 + X) = 625,000 + X
500,000 + 2X = 625,000 + X
X=125,000
15. X = 340,000 / 0.68 = 500,000