Chapter 16
Cash and marketable securities management
230
MULTIPLE CHOICE
Cash flow management
1. Which of the following actions would not be consistent with good management?
A.
Increased synchronization of cash flows.
B.
Minimize the use of float.
C.
Maintaining an average cash balance equal to that required as a
compensating balance or that which minimizes total cost.
D.
Use of checks and drafts in disbursing funds.
(rpcpa)
1. B
? The one which is not consistent with good management.
 Cash management deals with balancing the cash inflows of the business with that of
its cash outflows. In periods where additional cash is needed, the sources of
financing must be identified and activated. In periods of excessive cash, the viable
investments must be tapped. The following are indicative of good cash management:
 Maintaining an optimum cash balance that minimizes the total cost of cash or
maintaining a minimum cash balance that equals the required compensating
balance.
 Speed-up cash collections
 Effective credit standards, analysis and approval.
 Effective collection policies such as use of mailbox, pick up points,
electronic fund transfer, concentration banking, and updated and
accurate billing system.
 Delay cash payments
 Use of drafts.
 Use of checks for better internal control and to maximize float.
 Use of TGIF (Thank God, Its Friday) policy in the issuance of checks.
 Bill first, before payment policy.
Choice-letter “a”, “c” and “d” are all good cash management policies. Choiceletter “b”, minimizing the use of payment float, is not a good cash payment policy.
2. Which of the following investments is not likely to be a proper investment for
temporary idle cash?
A. Initial public offering of an established profitable conglomerate.
B. Commercial paper.
C. Treasury bills.
D. Treasury bonds due within one year.
(rpcpa)
2. D
? The one that is not likely to be a proper investment in temporary idle cash.
 Idle (or excess) cash ought to be used (or invested) somewhere to give a fair return
and contribute in increasing the common equity of the firm. If the excess cash is
temporary, place it in temporary investments. If the excess cash is permanent, place
it in permanent investments.
Chapter 16
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231
Temporary investments are those expected to be converted into cash in a short
notice. Examples of temporary investments are short-term time deposits, promissory
notes, Philippine Treasury Bills, negotiable instruments, and other short-term
commercial papers, and those in the securities but are readily marketable (such as
temporary investments in shares of stocks and bonds).
Initial public offering (IPO) of an established conglomerate, commercial papers
and treasury bills are examples of temporary investments. Treasury bonds within
one year, are not temporary in nature (e.g., one year) plus the fact that the
investments are in bonds (where the bond market is not active in the Philippine
financial markets) and that bonds are in treasury. Hence, choice-letter “d” is correct.
3. A precautionary motive for holding excess cash is
A. To enable a company to meet the cash demands from the normal flow of
business activity.
B. To enable a company to avail itself of a special inventory purchase before prices
rise to higher levels.
C. To enable a company to have cash to meet emergencies that may arise
periodically.
D. To avoid having to use the various types of lending arrangements available to
cover projected cash deficits.
(rpcpa)
3. C
? A precautionary motive for holding cash.
 Under normal conditions, there are three (3) reasons why businesses hold cash:
transactional motive, precautionary motive, and speculative motive. Transactional
motive relates to the daily and normal use of cash to finance the business daily
operating requirements. Precautionary motive relates to the occurrence of exigencies
or emergencies where extra cash is needed. Speculative motive refers to ability of
the company to stay ahead in competition by intellectually predicting business trends
(e.g., buying more inventory before prices increases in times of recession, also called
as black-marketing).
Choice-letter “c” is the correct answer; it refers to precautionary motive of holding
cash. Choice-letter “a” is a transactional motive. Choice-letter “b” is a speculative
motive. Choice-letter “d” relates to prudent cash planning and management.
4. The following practices will impact the cash flow of the company:
1. Sales personnel are unequivocally responsible for collecting their credit sales.
2. Sales commissions are based on collected invoices.
3. Statement of accounts receivable are reconciled with customers and regularly
sent for confirmation.
4. Automatic transfer of funds is arranged with banks regarding deposits of
branches.
Of the above, which will result to better cash flow?
A. All statements.
C. Statements 3 and 4 only.
B. Statements 1, 3, and 4 only.
D. Statement 4 only.
4. C
? The practice(s) that results to better cash flows.
(rpcpa)
Chapter 16

Cash and marketable securities management
232
Choice-letter “c” is correct. The practices mentioned in statements 3 and 4 refer to
collection policies. Reconciliation and confirmation of accounts with customers and
automatic transfer of funds regarding bank deposits of branches are meant to result
to better cash flows.
Statements 1 and 2 will result to weak cash flow controls since sales are
operating functions while collection of credit sales is a custodianship (e.g., treasurer’s
function). Combining these two functional responsibilities into the hand of a person
would diminish the effectiveness of internal control, and therefore, will not result to
better cash flows.
5. A compensating balance
A. Compensates a financial institution for services rendered by providing it with
deposits of funds.
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 leadtime.
D. Is the amount of prepaid interest on a loan.
(cma)
5. A
? A statement about compensating balance.
 A compensating balance is normally required by financing institutions to be
maintained or deposited by the borrower as his equity contribution on the amount
borrowed. Choice-letter “a” is correct. Effectively, a compensating balance increases
the effective borrowing rate by reducing the net proceeds of the amount borrowed.
Choice-letter “b” is incorrect because a compensating balance is used for cash
borrowings and not for marketable securities portfolio transactions. Choice-letter “c”
is incorrect because it refers to safety stock. Choice-letter “d” is incorrect because it
refers to discounted interest on the loan.
6. An automated clearing house (ACH) electronic transfer is a(an)
A. Electronic payment to a company’s account at a concentration bank.
B. Check that must be immediately cleared by the Bangko Sentral ng Pilipinas.
C. Computer-generated deposit ticket verifying deposit of funds.
D. Check like instrument drawn against the payor and not against the bank.
6. A
? A description about automated clearing house (ACH) electronic transfer.
 Electronic transfer (or electronic fund transfer or EFT) is a movement of cash balance
from an account to another using electronics technology. This is normally harnessed
by collecting companies to expedite collections from customers, near or far, by
means of electronic fund transfer services offered by banks and other financing
institutions. Choice-letter “a” is correct.
Choice-letter “b” is incorrect because it refers to outstanding checks, and a check
is not involved in EFT. Choice-letter “c” is incorrect because it relates to deposits
from various sources and not transfer of funds from specific customers. Choice-letter
“d” is incorrect because an EFT is not a check-like instrument.
Chapter 16
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233
7. A working capital technique that increases the payable float and therefore delays the
outflow of cash is
A. Concentration banking.
B. A draft.
C. Electronic data interchange (EDI).
D. A lockbox system.
(cma)
7. B
? A working capital technique that increases the payable float and delays the outflow of
cash.
 Float refers to the period of time a check or a draft is cleared through the banking
system. A draft is a 3-party instrument in which a drawer orders the drawee to pay
the money to the payee, and is a means of slowing cash outflows. It normally takes
an extra day to clear a draft than a check. Hence, choice-letter “b” is correct.
Choice-letters “a” and “d” are incorrect because concentration banking and
lockbox system are means of accelerating cash inflows. Choice-letter “c” is incorrect
because an EDI is an electronic technique used by suppliers and customers to
facilitate faster delivery of quality materials.
8. Which one of the following is not a characteristic of a negotiable certificate of
deposit? Negotiable certificates of deposit
A. Have a secondary market for investors.
B. Are regulated by the Bangko Sentral ng Pilipinas.
C. Are usually sold in denominations of a minimum of P100,000.
D. Have yields considerably greater than bankers’ acceptances and commercial
paper.
(cma)
8. D
 The description that is not a characteristic of negotiable certificate of deposit.
 A certificate of deposit (CD) is a form of savings deposit that cannot be withdrawn
before its maturity without incurring a higher penalty. Sometimes, it is called as the
certificate of time deposit. Other CDs may be traded, hence they are called as
negotiable certificate of deposit. This form of temporary investment is less risky than
that of commercial paper and bankers’ acceptances, and therefore yields a lower, not
higher, rate. Choice-letter “d” is correct.
Choice-letters “a”, “b”, and c” are incorrect because negotiable certificate of
deposits are negotiable and therefore have secondary market, regulated by BSP
since they are channeled through the banking sector, and are usually sold with
minimum denominations
9. The most direct way to prepare a cash budget for a manufacturing firm is to include
A. Projected sales, credit terms, and net invoice.
B. Projected net income, depreciation and goodwill amortization.
C. Projected purchases, percentages of purchases paid, and net income.
D. Projected sales and purchases, percentages of collections, and terms of
payments.
(cma)
9. D
? The items included in the direct way of preparing cash budget.
Chapter 16

10.
Cash and marketable securities management
234
Cash budget is the financial plan regarding cash inflows and outflows of a firm in a
given period. A cash budget prepared on a direct way itemizes cash receipts and
disbursements. The more visible components of a cash budget prepared on a direct
way are collections from customers and payments to merchandise suppliers,
salaries, and other important operating expenses. As such, choice-letter “d” is
correct. Budgeted collections from customers are coming from projected sales while
budgeted payments to suppliers originate from purchases.
Choice-letter “a” is incorrect because it does not include cash payments. Choiceletter “b” is incorrect because depreciation and goodwill amortizations are added
back to net income in computing the net cash flows from operations using the indirect
method of cash flows presentation. Choice-letter “c” is incorrect because it does not
include sources of cash receipts.
Given the following events, which affect cash flows from operations?
1. Cash sale
2. Cash dividends paid
3. Purchase of a long-term asset
4. Purchase of inventory
5. Paid employees
A. 1 and 5.
B. 1, 3, 4, and 5.
C. 1, 2 and 5.
D. 1, 4 and 5.
(rpcpa)
10. A
? The transactions that affect cash flows from operations.
 Choice-letter “a “ is correct; cash sale is a cash inflow from operations and payment
to employees is a cash outflow to operations.
Item no. 2, payment of cash dividend, is a financing activity. Item no. 3 does not
specify whether the purchase is cash or non-cash and if ever purchased on cash is to
be classified as an investing activity. Item no. 4 does not mention whether the
purchase of inventory is on cash, hence, assumed to have been made on account.
11. MM Corporation had income before taxes of P60,000 for the year 2006. Included in
this amount was depreciation of P5,000, a charge of P6,000 for the amortization of
bond discounts, and P4,000 for interest expense. The estimated cash flow for the
period is
A. P60,000
C. P49,000
B. P66,000
D. P71,000
(cma)
11. D
? The estimated cash flow for the period.
 The cash flow from operations may be computed using the indirect method of cash
flow presentation, as follows:
Income before income taxes
P60,000
± Non-cash items:
Depreciation expense
5,000
Bond discounts amortization
6,000
Net cash inflow from operations
P71,000
Chapter 16
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235
The income before income taxes automatically becomes the net income because
there is no applicable tax rate given.
12. Bing and Bong’s Store is on the cash basis of preparing it funds statement. These
data are available:
Decrease in working capital P50,000
Depreciation
13,000
Increase in cash
25,000
Repairs and maintenance
19,500
Total uses of cash
454,000
Calculate the total sources of cash of Bing and Bong’s Store .
A. P472,500
C. P479,000
B. P492,000
D. P467,000
(rpcpa)
12. C
? The total sources of cash.
 The total use of cash is given together with the increase in cash balance. Based on
the data given in the problem, the total sources of ash is P479,000, as determined
below:
Total uses of cash
P454,000
Add: Increase in cash
25,000
Total sources of cash
P479,000
Better still, if the cash balance beginning is given. The total sources of cash shall
then be cash balance beginning plus total uses of cash.
13. Shown below is a forecast of sales for Carlos Inc. for the first four months of 2006 (all
amounts are in thousand of pesos).
2006
January February March April
Cash sales
P 15
P 24
P 18 P 14
Sales on credit 100
120
90
70
On average, 50% of credit sales are paid for in the month of sale, 30% in the month
following the sale, and the remainder is paid 2 months after the month of sale.
Assuming there are no bad debts, the expected cash inflow for Carlos in March is
A. P138,000
C. P119.000
B. P122,000
D. P108,000
(cma)
13. C
 The expected cash inflows in March 2006.
 The credit sales collection pattern is 50-30-20, which means that March credit sales
collection will come from January sales (20%), February sales (30%), and March
sales (50%), as follows:
Collections from credit sales:
January sales (P100,000 x 20%)
P 20,000
February sales (P120,000 x 30%)
36,000
March sales (P90,000 x 50%)
45,000
Chapter 16
Cash and marketable securities management
Cash sales
Cash inflows in March 2006
236
18,000
P119,000
14. Assume that each day a company writes and received checks totaling P10,000. If it
takes 5 days for the checks to clear and be deducted from the company’s account,
and only 4 days for the deposits to clear, what is the float?
A. P10,000
C. P(10,000)
B. P
0
D. P50,000
(cma)
14. A
? The amount of the float.
 The float referred here is the net float. A float is a time spent between the day the
check is written until the day the check is withdrawable or the deposit is cleared. The
net float refers to the difference of the check float and the deposit float, as follows:
Check float (P10,000 x 5 days)
P50,000
Deposit float (P10,000 x 4 days)
( 40,000)
Net float
(P10,000 x 1 day)
P10,000
15. Butit is a newly established janitorial firm, and the owner is deciding what type of
checking account to open. Butit is planning to keep a P500 minimum balance in the
account for emergencies and plans to write roughly 80 checks per month. The bank
charges P10 per month per P0.10 per check charge for a standard business
checking account with no minimum balance. Butit also has the option of a premium
business balance that requires a P2,500 minimum balance but has no monthly fees
or per check charges. If Butit’s cost of funds is 10%, which account should Butit
choose?
A. Standard account, because the savings is P34 per year.
B. Premium account, because the savings is P34 per year.
C. Standard account because the savings is P16 per year.
D. Premium account because the savings is P16 per year.
(cma)
15. D
? The checking account that should be chosen.
 The checking account to be maintained should give the lower cost of using the
checking account facility, as follows:
Cost of using a standard checking account
Bank charges [P10 + (80 x P0.10) x 12 mos.]
P216.00
Cost of funds (P500 x 10%)
50.00
P266.00
Cost of using premium checking account (P2,500 x 10%)
250.00
Advantage of using the premium checking account
P 16.00
16. Globe Products has received proposals from several banks to establish a lock box
system to speed up receipts. Globe receives an average of 700 checks per day
averaging P1,800 each, and its cost of short-term funds is 7% per year. Assuming
that all proposals will produce equivalent processing results and using a 360-day
year, which one of the following proposals is optimal for Globe?
A. A P0.50 per check.
B. A flat fee of P125,000 per year.
Chapter 16
Cash and marketable securities management
C. A fee of 0.03% of the amount collected.
D. A compensating balance of P1,750,000.
237
(cma)
16. D
? The optimal proposal received from several banks.
 The business receives 700 checks per day, an average of P1,800 a day, and a cost
of funds of 7% per year. The costs of the several proposals are:
Cost of proposals
a. P0.50 per check (700 checks x P0.50 x 360 days) P126,000
b. Flat fee
125,000
c. 0.03% of amount collected
(P1,800 x 700 checks x 360 days x 0,03%)
136,080
d. Compensating balance (P1,750,000 x 7%)
122,500 (lowest)
Proposal “d”, maintaining a compensating balance of 1,750,000 would only cost the
business P122,500, and has the lowest cost among the proposals submitted, and
therefore is the most desirable and optimal proposal.
17. Franklin, Inc., is a medium-size manufacturer of toys that makes 25% of its sales to
Mel Company, a major national discount retailing firm. Mel will be requiring Franklin
and other suppliers to use Electronic Data Interchange (EDI) for inventory
replenishment and trade payments transactions as opposed to the paper-based
systems previously used. Franklin would consider all of the following to be
advantages using EDI in its dealings with Mel except
A. Access to Mel’s inventory balances of Franklin’s products.
B. Better status of deliveries and payments.
C. Compatibility with Franklin’s other procedures and systems.
D. Reduction in the payment float.
(cma)
17. D
? A disadvantage using EDI in dealing with a supplier.
 Electronic data interchange (EDI) is an electronic system where a company that has
an interest over the operational schedules of another (e.g., its customers) taps the
advantages of advance communication and computer technologies in order to deliver
services on time and upholding the best interest of the receiving party. For example,
this method allows a supplier to dip or access over the database of its customer to
predict production needs and serve schedules on time to eliminate delays (or
production float) in the production process. This process ensures better status of
deliveries and results to timely payments on the part of the buying party. Choiceletters “a”, “b”, and “c” are advantages of the EDI and are not the correct answers.
Choice-letter “d” is incorrect and is the correct answer because reduction in the
payment float would not lengthen the payment period and is a disadvantage using
the EDI.
18. If the average age of inventory is 60 days, the average age of the accounts payable
is 30 days, and the average age of accounts receivables is 45 days, the number of
days in the cash flow cycle is
A. 135 days.
C. 75 days.
Chapter 16
B.
90 days
Cash and marketable securities management
.
238
D. 105 days.
18. C
? The number of days in the cash flow cycle.
 Net cash flow cycle is operating cycle less payment period. Operating cycle is the
sum of collection period plus days to sell inventory, as follows:
Operating cycle (45 days + 60 days) 105 days
- Payment period
30 days
Net cash flow cycle
75 days
19. RMN is a retail mail order firm that currently uses a central collection system that
requires all checks to be sent to its flotation headquarters. An average of 6 days is
required for mailed checks to be received, 3 days for RMN to process them, and 2
days for the checks to clear through its bank. A proposed lockbox system would
reduce the mailing and processing time to 2 days and the check clearing time for 1
day. RMN has an average daily collection of P150,000. If RMN adopts the lockbox
system, its average cash balance will increase by
A. P1,200,000
C. P600,000
B. P 750,000
D. P450,000
19. A
? The increase in the average cash balance if the company adopts the lockbox system.
 The average cash balance is an increase of 5 days, presented as follows:
Old check processing time (6 + 3 + 2)
11 days
- Lockbox system (2 + 1)
3 days
Reduction in the collection time
8 days
Increase in average cash balance (P150,000 x 8 days) P1,200,000
20. A firm has a daily cash receipts of P100,000 and collection time of 2 days. A bank
has offered to reduce the collection time on the firm’s deposits by 2 days for a
monthly fee of P500. If money market rates are expected to average 6% during the
year, the net annual benefit (loss) from having this service is
A. P 3,000
C. P
0
B. P12,000
D. P6,000
(cma)
20. D
? The net annual benefit (loss).
 The benefit arises from reduced collection time by days in which cash may be
invested at an average return of 6% per year. The cost of the accelerated collection
period is the bank monthly charge of P500. The net benefit is determined as follows:
Benefit from accelerated collection
(P100,000 x 2 days x 6%)
P12,000
- Bank charges (P500 x 12 mos.)
6,000
Net benefit from reduced collection time
P 6,000
21. Troy Toy is a retailer operating in several cities. The individual store managers
deposit daily collections at a local bank in a non-interest bearing checking account.
Twice per week, the local bank issued a depository transfer check (DTC) to the
Chapter 16
Cash and marketable securities management
239
central bank at headquarters. The controller of the company is considering using a
wire transfer instead. The additional cost of each transfer would be P25; collections
would be accelerated by 2 days, and the annual interest rate paid by the central bank
is 7.2% (0.02% per day). At what amount of pesos transferred would it be
economically feasible to use a wire transfer instead of the DTC? Assume a 350-day
year.
A. It would never be economically feasible.
B. P125,000 or above.
C. Any amount greater than P173.
D. Any amount greater than P62,500.
(cma)
21. D
? The amount to be transferred to be economically feasible to use a wire transfer
instead of the DTC.
 If the wire transfer is used, a cost of P25 is incurred. The benefit from the use of wire
transfer is the interest of .02% a day or .04% for 2 days. The minimum amount that
should be transferred to at least cover the P25 cost is P62,500 (i.e., P25/0.04%).
Choice-letter “a” is incorrect because it is feasible to use wire transfer if the
amount of cash to be transferred is P62,500 or more. Choice-letters “b” and “c” are
incorrect because the minimum amount of transfer should be P62,500 or more.
22. A company uses the following formula in determining the optimal level of cash
if: b = fixed cost per transaction
C =
2bt / I
I = interest rate on marketable securities
t = total demand for cash over a period of time
This formula is a modification of the economic order quantity (EOQ) formula used for
inventory management. Assume that the fixed cost of selling marketable securities is
P10 per transaction and the interest rate on marketable securities is 6% per year.
The company estimates that it will make cash payments of P12,000 over the onemonth period. What is the average cash balance (rounded to the nearest peso)?
A. P1,000
C. P3,464
B. P2,000
D. P6,928
(cma)
22. C
? The average cash balance.
 The total annual cash payments are P144,000 (i.e., P12,000 x 12 months). The
optimal cash balance is P6,928, computed as follows:
C =
C =
2 x P144,000 x P10
6%
P6,928
The average cash balance is P3,464 (i.e., P6928 / 2 ).
23. A firm has daily cash receipts of P300,000. A bank has offered to provide a lockbox
service that will reduce the collection time by 3 days. The bank requires a monthly
fee of P2,000 for providing this service. If monthly market rates are expected to
Chapter 16
Cash and marketable securities management
240
average 6% during the year, the additional annual income (loss) of using the lockbox
system is
A. P(24,000)
C. P30,000
B. P12,000
D. P54,000
(ing)
23. C
 The additional annual income (loss) of using the lockbox system.
 The benefit-cost analysis should be used. The benefit from the use of the lockbox
system reduces the collection time by 3 days, which means that the collected amount
may by invested to earn a return of 6%. The related cost in using the lockbox system
is the bank’s monthly charges of P2,000. The net benefit (loss) from the use of the
lockbox system is P30,000, determined as follows:
Benefit from accelerated collection (P300,000 x 3 days x 6%)
P54,000
- Bank charges (P2,000 x 12 mos.)
24,000
Net benefit from using the lockbox system
P30,000
24. The treasury analyst for KG Manufacturing has estimated the cash flows for the first
half of next year (ignoring any short-term borrowings) as follows:
Cash (millions)
Inflows
Outflows
January
P 2
P 1
February
2
4
March
2
5
April
2
3
May
4
2
June
5
3
KG has a line of credit up to P4 million on which it pays interest monthly at a rate of
1% of the amount utilized. KG is expected to have a cash balance of P2 million on
January 1 and no amount utilized on its line of credit. Assuming all cash flows occur
at the end of the month, approximately how much will KG pay in interest during the
first half of the year?
A. Zero
C. P 50,000
B. P61,000
D. P132,000
(cma)
24. B
 The amount of interest paid during the first half of the year.
 The amount of interest paid is 1% per month of the outstanding balance of amount
borrowed, computed as follows:
Monthly net Cash balance
Financing Flows
cash inflows before
Borrowings
Date
(outflows) borrowings
(Payments) Interest paid
Jan 1
P2,000,000 P
0
P
0
P
0
Jan
1,000,000 3,000,000
0
0
Feb 28
(2,000,000) 1,000,000
0
0
Mar 31
(3,000,000) (2,000,000)
2,000,000
0
Apr 30
(1,000,000) (1,000,000)
1,000,000
20,000 (P2,000,000 x 1%)
May 31
2,000,000
0
(1,949,800)
30,200 (P3,020,000 x 1%)
Chapter 16
Jun 30
Cash and marketable securities management
2,000,000
939,298
(1,050,200)
241
10,502 (P1,050,200 x 1%)
P60,702
The total interest to be paid from January 1 to June 30 is P60,702, choice-letter “b” is
the nearest answer.
The interest paid on May 31 is based on P3,020,000 (i.e., P2,000,000 +
P1,000,000 + P20,000). The interest incurred on April 30 and unpaid in May also
earns interest. The total borrowings paid on May 31 is P1,949,800 (i.e., P2,000,000
– P50,200). The total interest of P50,200 (i.e., P20,000 + P30,200) is paid on May
31.
In June, the interest is based on the outstanding borrowings of P1,050,200 (i.e.,
P3,000,000 – P1,949,800). And the June 30 cash balance is P939,298 (i.e.,
P2,000,000 – P1,050,200 – P10,502).
Effective interest rate
25. On January 07, 2006, Dean Company discounted its own P100,000, 180-day note at
United National Bank at a discount rate of 20%. Dean repaid the note on the July 6,
2005, due date. Based on a 360-day year, the effective rate of interest on the
borrowing was
A. 18.2%
C. 22.2%
B. 20.0%
D. 25.0%
(aicpa)
25. D
? The effective interest-borrowing rate.

Effective interest borrowing rate is the true rate of interest rate paid or incurred by
the business. The basis of the interest rate is the proceeds from borrowing. In this
case, the effective borrowing rate is 25% [i.e., 20% / (100% - 20%)]. The interest is
deducted in advance because it is discounted.
26. A company obtained a short-term bank loan of P250,000 at an annual interest of 6%.
As a condition of the loan, the company is required to maintain a compensating
balance of P50,000 in its checking account. The company’s checking account earns
interest at an annual rate of 2%. Ordinarily, the company maintains a balance of
P25,000 in its checking account for transaction purposes. What is the effective
interest rate of the loan?
A. 6.44%
C. 5.80%
B. 7.00%
D. 6.66%
(cma)
26. A
? The effective interest rate of the loan.
 Effective interest borrowing rate (EIBR) is the true interest rate paid by the business
on the amount borrowed. EIBR is net interest expense divided by net proceeds of
borrowings. The basis of the effective interest rate is the proceeds from borrowing,
not the principal amount borrowed. Interest payments should be adjusted with
related interest revenue that may be derived from the conditions set in the borrowing
agreement (such as interest revenue from compensating balance).
In this problem, the interest paid is P15,000 (i.e., P250,000 x 6%). The
compensating balance of the company should be increased by P25,000 (i.e.,
P50,000 – P25,000) and earns an interest revenue of P500 (i.e., P25,000 x 2%). The
Chapter 16
Cash and marketable securities management
net proceeds from borrowings are P225,000 (i.e., P250,000 – P25,000).
effective interest-borrowing rate is computed as follows:
EIBR = Net interest paid / Net proceeds
= (P15,000 – P500) / P225,000
= P14,500 / P225,000 = 6.44%
242
The
27. Hager Company’s bank requires a compensating balance of 20% on a P100,000
loan. If the stated interest on the loan is 7%, what is the effective cost of the loan?
A. 5.83%
C. 6.40%
B. 7.00%
D. 8.75%
(cma)
27. D
? The effective cost of the loan.
 The effective cost of the loan is determined by dividing the net interest expense over
the net proceeds of the loan. The interest expense associated with the loan is
P7,000, and the net proceeds of the loan is P800,000 (i.e., P1 million x 80%). The
effective cost of the loan is 8.7%, as follows:
Effective loan rate = P7,000 ÷ P800,000 = 8.75%
28. Meals Etc. has been very successful. It is the newest fast food outlet at the Greenbelt
of Makati featuring ordinary Filipino food packed with banana leaves. After six months
of operations, it needs to expand. The owner, Mr. K. Eng estimates that P2.4 million
will be required to put up another outlet in the Ortigas area.
Financing was offered by a friendly banker at 10 percent discounted interest.
Alternatively, Mr. Eng is thinking of just delaying payment to its suppliers. All his sales
are on cash basis. The company purchases under terms of 2/10, net 40 but Mr. Eng
believes that he could delay payments by another 30 days without any problem. This
means payment could be made in 70 delays. Assuming 360 days a year, Meals Etc.
should opt for
A. Bank loan since its cost of 11.11% is cheaper than the cost of delaying payments
of 12.24%.
B. Delaying payments since it has no cost compared to the 10% discounted bank
interest.
C. Bank loan since it costs of 10% is cheaper than the cost of delaying payments of
12%.
D. Delaying payments since it costs only 2% compared to 10% discounted bank
interest.
(rpcpa)
28. A
? The better short-term financing alternative.
 The two short-term financing alternatives are: (1) borrow from the bank, or (2) delay
payments to suppliers. The effective cost of financing for each alternative is as
follows:
a. Borrow from a bank
Effective interest rate = [10% / (100% - 10%)] = 11.11%
b. Delay payments to suppliers
Effective discount rate = (360/60) x (2%/98%) = 12.24%
Chapter 16
Cash and marketable securities management
243
It is better for the firm to borrow from a local bank and pay a lower cost of shortterm financing at 11.11%.
29. Butuan Company recently received a commercial bank loan of 16% discounted rate
with a 20% compensating balance. The term of the loan is one year. The effective
cost of borrowing is:
A. 19.05%
C. 22.85%
B. 20.00%
D. 25.00%
(rpcpa)
29. D
? The effective cost of borrowing.
 Effective interest borrowing rate is the true interest rate paid by the business. The
basis of the interest rate is the proceeds from borrowing and not the principal amount
borrowed. Interest payments should be adjusted with related interest revenue that
may be derived from the conditions set in the borrowing agreement (such as interest
revenue from compensating balance).
Based on the given data, the effective interest rate is:
Effective interest rate = Interest rate / (Principal – Interest rate – Compensating balance)
= 16% / (100% - 16% - 20%) = 16% / 64% = 25%
30. Cool and Sweet obtained a short-term bank loan for P1 million at an annual interest
of 12%. As a condition of the loan, the company is required to maintain a
compensating balance of P200,000 in its savings account which earns interest at an
annual rate of 6%. The company would otherwise maintain only P100,000 on the
savings account for transactional purposes. The effective cost of the loan is
A. 13.20%
C. 12%
B. 12.67%
D. 13.5%
(rpcpa)
30. B
? The effective cost of the loan.
 The effective loan rate is equal to net interest expense paid divided by net amount
received. The computation is shown below:
Regular interest expense (P1 million x 12%)
P120,000
Interest income on compensating balance (P100,000 x 6%) ( 6,000)
Net interest incurred
114,000
/ by Net amount received :
Principal
P1,000,000
Increase in compensating balance
(100,000)
900,000
Effective interest rate
12.67%
Net interest paid equals the regular interest payments less the interest revenue
from the compensating balance. The increase in compensating balance decreases
the net proceeds. The loan is not discounted, as such the interest is not deducted in
advance.
31. The Ralph, Inc. signed a loan agreement subject to the following terms:
1. Stated interest rate of 18% on a one-year discounted loan; and
2. 15% compensating non-interest bearing checking account balance to be
maintained by Ralph Inc., with Manila Commercial Bank
Chapter 16
Cash and marketable securities management
244
The net proceeds of the loan was P1 million. The principal amount of the loan was
A. P1,176,471
B. P1,000,000
C. P1,492,537
D. P1,219,512
(rpcpa)
31. C
? The principal amount of the loan.
 The net proceeds of the loan is P1 million. The discounted interest is 18% and the
compensating balance is 15%. The net proceeds rate is 67% (i.e., 100% - 15% 18%). The amount of the principal is P1,492,537.00 computed by dividing P1 million
over 67%.
Discounted interest means that the interest is deducted in advance.
Marketable securities management
32. When managing cash and short-term investments, a corporate treasurer is primarily
concerned with
A. Maximizing the rate of return.
B. Maximizing taxes.
C. Investing in Treasury bonds since they have no default mix.
D. Liquidity and safety.
32. D
? An area of concern of a corporate treasurer with respect to managing cash and shortterm investments.
 A corporate treasurer is concerned about liquidity and safety in managing cash and
short-term investments. Managing short-term liquidity needs precision in timing cash
flows in order to avoid unnecessary delays or failures in paying currently maturing
obligations as they fall due. Sufficient liquidity must always be established to
minimize the risk of technical bankruptcy. This is done by ensuring enough cash to
meet payments of crucial operating expenses. Short-term investments are made
under the criteria that their convertibility to cash is immediate and assured, with
secondary interests on their possible returns.
Choice-letter “a” is incorrect because ordinary businesses are established to
maximize earnings from their main source of revenue and not from secondary
sources of revenue. Choice-letter “b” is incorrect because maximizing taxes is an
antithesis of business goals. Choice-letter “c” is incorrect because treasury bonds
are not short-term investments.
33. All of the following are alternative marketable securities suitable for investment
except
A. RP Treasury Bills.
C. Commercial paper.
B. Eurodollars.
D. Convertible bonds.
(cma)
33. D
? An investment, which is not an alternative marketable securities.
 Marketable securities are equity papers representing ownership and credit
accommodations expected to earn a reasonable return. Examples of marketable
Chapter 16
Cash and marketable securities management
245
securities are listed company’s shares of stocks and bond certificates. Aside from
marketable securities, there are alternative temporary investments where temporary
excess cash may invested such as treasury bills, commercial papers, and, recently,
eurodollars. Hence, choice-letters “a”, “b”, and “c” are incorrect because they are not
exception to the alternative marketable securities.
Choice-letter “d” is the right answer because convertible bonds are normally
long-term in nature and are therefore not temporary.
34. The term short selling is the
A. Selling of a security that was purchased by borrowing money from a broker.
B. Selling of a security that is not owned by the seller.
C. Selling of all the shares you own in a company in anticipation that the price will
decline dramatically.
D.
Betting that stock will increase by a certain amount within a given period of time. (cma)
34. B
? A statement of description about short selling.
 Choice-letter “b” is correct. Short selling is done be selling securities not owned by
the seller but is borrowed or on loaned from a broker. Later, the securities are
returned by buying the same securities in the open market at a lower price. This is
one area of speculative stock selling.
Choice-letter “a” is incorrect because it refers to margin trading where the
securities are purchased by borrowing from a broker and selling the same securities
at expectedly higher price, pay the broker, and profit along the way. Choice-letter “c”
is incorrect because in short selling the securities are not owned by the seller.
Choice-letter “d” is incorrect because in short selling the seller is betting that the
stock price will decrease at a later time.
 done 
Chapter 16
Cash and marketable securities management
246