When a balance sheet amount is related to an income statement amount in computing a ratio
CMA 1287 4-1
The balance sheet amount should be converted to an average for the year.
The income statement amount should be converted to an average for the year.
Both amounts should be converted to market value.
Comparisons with industry ratios are not meaningful.
Ans.
The balance sheet amount should be converted to an average for the year.
The following common size income statement is available for Sparky Corporation for the two years
ended December 31, 2017 and 2018:
2017
2018
Sales
100%
100%
Cost of sales
55
70
Gross profit on sales
45
30
Operating expenses
(including income tax expense)
20
18
Profit
25%
12%
The trend percentages for sales are as follows:
58.5% 130% 150% 195%
Ans.
150%
On December 31, 2013, Pagudpod Company collected a receivable due from a major customer. Which of
the following ratios would be increased by this transaction?
Inventory turnover ratio. Quick ratio. Receivable turnover ratio. Current ratio.
Ans.
Receivable turnover ratio.
Cebu Corporation’s books disclosed the following information as of and for the year ended December 31,
2018:
Net credit sales
P2,000,000
Net cash sales
500,000
Merchandise purchases
1,000,000
Inventory at beginning
600,000
Inventory at end
200,000
Accounts receivable at beginning
300,000
Accounts receivable at end
700,000
Profit
100,000
Marble’s percent of profit on sales is
4% 9% 44% 56%
Ans.
4%
Securing of funds for investment at a fixed rate of return to fund suppliers to enhance the wellbeing of
the ordinary shareholders is known as:
Financial leverage
Fund management.
Prudent borrowing.
Financial arbitrage.
Ans.
Financial leverage
When a balance sheet amount is related to an income statement amount in computing a ratio.
The income statement amount should be converted to an average for the year.
Comparison with industry ratios is not meaningful.
The balance sheet amount should be converted to an average for the year.
The ratio loses its historical perspective because a beginning of the year amount is combined with an
end of the year amount.
Ans.
The balance sheet amount should be converted to an average for the year.
Which of the following does not belong to the list?
Common-size financial statements.
Peso and percentage changes on financial statements.
Financial ratios
Long-form report
Ans.
Long-form report
Titles of ratios frequently include the terms “on” and “to.” When used in ratio titles, these terms imply
the use of which one of the following mathematical functions?
Subtraction. Multiplication. Division. Squaring.
Ans.
Division.
Assume the following sales data for a company:
2005
P1,000,000
2004
900,000
2003
750,000
2002
600,000
If 2002 is the base year, what is the percentage increase in sales from 2002 to 2003?
125% 167% 25% 20%
Ans.
25%
Northern Division reported the following results for 2018:
Annual sales
Net earnings
Investment
P500,000
80,000
250,000
What is Northern Division’s return on sales?
16% 20% 25% 32%
Ans.
16%
The following data pertain to ABC Corporation for the calendar year 2018:
Profit
Dividends paid on ordinary shares
Ordinary shares outstanding (unchanged during the year)
P 240,000
P 120,000
300,000 shares
The market price per share of ABC’s ordinary shares at December 31, 2018 was P12. The price- earnings
ratio at December 31, 2018 was
9.6 to 1 10.0 to 1 15.0 to 1 30.0 to 1
Ans.
15.0 to 1
A balance sheet that displays only component percentages is called a ________ balance sheet.
condensed common size comparative trendy
Ans.
common size
Which of the following is least likely to be a major purpose or type of ratio or measure used in financial
management?
Solvency. Operational activity. Price indexes. Liquidity.
Ans.
Price indexes.
Horizontal analysis is also known as
linear analysis. vertical analysis. trend analysis. common size analysis.
Ans.
trend analysis.
This ratio of analytical measurement measures the productivity of assets regardless of capital structures.
Return on total assets. Quick ratio. Current ratio. Debt ratio.
Ans.
Return on total assets.
In 2016, MJP Corporation’s profit was P800,000 and in 2017 it was P200,000. What percentage increase
in profit must MPX achieve in 2018 to offset the 2017 decline in profit? 60% 600% 400% 300%
Ans.
300%
Index numbers would probably be most interested in which ratio?
Trend analysis. Ratio analysis. Vertical analysis. Common-size statements.
Ans.
Trend analysis.
A major problem in comparing profitability measures among companies is the
Lack of general agreement over which profitability.
Differences in the size of the companies.
Differences in the accounting methods used by the companies.
Differences in the dividend policies of the companies.
Ans.
Differences in the accounting methods used by the companies.
Which of these ratios are measures of a company’s profitability?
1.
2.
3.
4.
Earnings per share
Current ratio
Return on sales
Debt-equity ratio
5. Return on assets
6. Inventory turnover
7. Receivables turnover
8. Price earnings ratio
All eight ratios. 1, 3, 5 and 8 only. 1, 3, 5, 6, 7 and 8 only. 1, 3 and 5 only.
Ans.
1, 3 and 5 only.
At December 31, 2018, Morgan, Inc., had 100,000 shares of P10 par value ordinary shares issued and
outstanding. There was no change in the number of shares outstanding during 2018. Total
shareholders’ equity at December 31, 2018, was P2,800,000. The profit for the year ended December
31, 2018, was P800,000. During 2018 Morgan paid P3 per share in dividends on its ordinary shares. The
quoted market value of Morgan’s ordinary shares was P48 per share on December 31, 2018. What was
the price-earnings ratio on ordinary shares for 2018?
9.6 to 1 8.0 to 1 6.0 to 1 3.5 to 1
Ans.
6.0 to 1
Nory Company is preparing its common-size financial statements and revealed the following information
(in thousands of pesos):
Accounts receivable
Inventory
Total current assets
Total assets
Bonds payable
Retained earnings
Sales revenue
Cost of goods sold
Income taxes expense
10,000
20,000
35,000
84,000
21,000
7,000
75,000
62,000
22,000
How would Nory’s retained earnings appear on a common-size balance sheet?
8.3% 9.4% 20.0% 33.3%
Ans.
8.3%
Nory Company is preparing its common-size financial statements and revealed the following information
(in thousands of pesos):
Accounts receivable 10,000
Inventory
20,000
Total current assets 35,000
Total assets
84,000
Bonds payable
21,000
Retained earnings
7,000
Sales revenue
75,000
Cost of goods sold
62,000
Income taxes expense
22,000
How would Nory’s inventory appear on a common-size balance sheet?
11.9 % 23.8 % 57.15% 65.3 %
Ans.
23.8 %
Data pertaining to Classics Corp.’s ordinary shares are presented for the fiscal year ending May 31, 2018:
Ordinary shares outstanding
P750,000
Stated value per share
15.00
Market price per share
45.00
2017 dividends paid per share
4.50
2018 dividends paid per share
7.50
Basic earnings per share 11.25
Diluted earnings per share
9.00
The price earnings ratio of ordinary shares of Classics Corp is:
3.0 times. 7.0 times. 6.0 times. 5.0 times.
Ans.
5.0 times.
It refers to the practice of financing assets with borrowed capital. Its extensive use may impact on the
return on ordinary shareholders’ equity to be above or below the rate or return on total assets.
Discounting. Mortgage. Leverage. Arbitrage.
Ans.
Leverage.
Which of the following statements concerning ratio analysis is/are correct?
I.
Ratio analysis uses only monetary measures for analysis purposes.
II.
Ratio analysis uses only measures from financial statements for analysis purposes.
I only. II only. Both I and II. Neither I nor II.
Ans.
Neither I nor II.
Northern Division reported the following results for 2018:
Annual sales
Net earnings
Investment
P500,000
80,000
250,000
What is Northern Division’s asset turnover?
0.5 to 1 1 to 1 2 to 1 3.125 to 1
Ans.
2 to 1
If the return on total assets is 10% and if the return on ordinary shareholders’ equity is 12% then
The after-tax cost of long-term debt is probably greater than 10%.
The after-tax cost of long-term debt is 12%.
Leverage is negative.
The after-tax cost of long-term debt is probably less than 10%.
Ans.
The after-tax cost of long-term debt is probably less than 10%.
Which of the following is not a limitation of ratio analysis affecting comparability among firms? Different
accounting policies.
Different fiscal years.
Different sources of information.
All of the choices are limitations of ratio analysis.
Ans.
All of the choices are limitations of ratio analysis.
The following common size income statement is available for Sparky Corporation for the two years
ended December 31, 20PY and 20CY:
20PY 20CY
Sales 100% 100%
Cost of sale
55
70
Gross profit on sales
45
30
Operating expenses (including income tax expense)
20
18
Profit 25%
12%
The trend percentages for sales are as follows:
20PY
130%
20CY
100%
What should be the trend percentage for gross profit on sales for 20CY?
58.5% 130% 150% 195%
Ans.
195%
Cascade Company had sales of $300,000 in Year 1 and the price index for its industry is expected to rise
from 300 in Year 1 to 320 in Year 2. The level of sales that Cascade must reach in Year 2 in order to
achieve a real growth rate of 20% is $360,000. $320,000. $337,500. $384,000.
Ans.
$384,000.
Which of the following is the worst limitation of ratio analysis affecting comparability from one interim
period to the next within a firm?
Management has an incentive to window dress financial statements to improve results.
In a seasonal business, inventory and receivables may vary widely with year-end balances not reflecting
the averages for the period.
Comparability is impaired if different firms use different accounting policies.
Generalizations about which ratios are strong indicators of a firm's financial position may change from
industry to industry and firm to firm.
Ans.
In a seasonal business, inventory and receivables may vary widely with year-end balances not reflecting
the averages for the period.
Presented below are partial year-end financial statement data for companies A and B.
Company A
Company B
Cash $100 $200
Accounts Receivable
unknown
Inventories
unknown
100
Net Fixed Assets
200
100
Accounts Payable
100
50
Long-Term Debt200
50
Common Stock 100
200
100
Retained Earnings
150
100
Company A
Company B
Sales $600 $5,800
Cost of Goods Sold
300
5,000
Administrative Expenses
100
500
Depreciation Expense 100
100
Interest Expense
20
10
Income Tax Expense
40
95
Net Income
40
95
If Company A has 60 common shares outstanding, then it has a book value per share, to the nearest
cent, of
$1.67 $2.50 $4.17 $5.00
Ans.
$4.17
Ratio analysis and related measures can be used to compare:
1) A Firm Over Time
2) Across Firms
1) Yes
1) Yes
1) No
1) No
Ans.
1) Yes
2)
2)
2)
2)
Yes
No
Yes
No
2) Yes
In financial statements analysis, expressing all financial statement items as a percentage of base-year
amounts is called
Horizontal common-size analysis.
Vertical common-size analysis.
Trend analysis.
Ratio analysis.
Ans.
Horizontal common-size analysis.
Which of the following financial statement analyses is most useful in determining whether the various
expenses of a given company are higher or lower than industry averages?
CIA 0593 IV-39
Horizontal. Vertical. Activity ratio. Trend.
Ans.
Vertical.
In 20PY, MJP Corporation’s profit was P800,000 and in 20CY it was P200,000. What percentage increase
in profit must MPX achieve in 20NY to offset the 20CY decline in profit? 60% 600% 400% 300%
Ans.
300%
Under GAAP, comparative financial statements are
Required for at least the current and the prior year.
Required for at least the current and the prior 2 years.
Recommended for at least the current and the prior year.
Neither required nor recommended.
Ans.
Recommended for at least the current and the prior year.
Assume the following abbreviated Balance Sheet:
Current Assets P100,000
Current Liabilities
P30,000
Investments
25,000
Long-term Liabilities
75,000
Fixed Assets
75,000
Common Stock 70,000
Retained Earnings
25,000
Total Assets
P200,000
Total L + Equity P200,000
In common-sized balance sheet, which one of the following percentages would be shown for current
liabilities?
15.0% 17.6% 28.5% 30.0%
Ans.
15.0%
An income statement showing only component percentages is known as?
Common pesos statement.
Condensed income statement.
Common-size income statement.
Comparative income statement.
Ans.
Common-size income statement.
The P/E ratio for a share of common stock is computed as:
Revenues
P100,000
Cost of Goods Sold
60,000
Gross Profit
P 40,000
Operating Expense
20,000
Finance Expense
5,000
Net Income
P 15,000
In a common-size income statement, which one of the following percentages would be shown for
Finance Expense?
33.33% 12.50% 8.33% 5.00%
Ans.
5.00%
In assessing the financial prospects for a firm, financial analysts use various techniques. Which of the
following is an example of vertical common-size analysis? CMA 1295 2-21
An assessment of the relative stability of a firm's level of vertical integration.
comparison in financial ratio form between two or more firms in the same industry.
A statement that current advertising expense is 2% greater than in the prior year.
A statement that current advertising expense is 2% of sales.
Ans.
A statement that current advertising expense is 2% of sales.
Horizontal, vertical, and common-size analyses are techniques that are used by analysts in understanding
the financial statements of companies. Which of the following is an example of vertical, common-size
analysis?
Commission expense in 20CY is 10% greater than it was in 20PY
A comparison in financial ratio between two or more firms in the same industry.
A comparison in financial form between two or more firms in different industries.
Commission expense in 20CY is 5% of sales.
Ans.
Commission expense in 20CY is 5% of sales.
When compared to a debt to assets ratio, a debt to equity ratio would?
CMA 0687 4-27
Be about the same as the debt to assets ratio.
Be higher than the debt to assets ratio.
Be lower than the debt to assets ratio.
Have no relationship at all to the debt to assets ratio.
Ans.
Be higher than the debt to assets ratio.
All of the following statements are correct except.
The matching of asset and liability maturities is considered desirable because this strategy minimizes
interest rate risk.
Default risk refers to the inability of the firm to pay off its maturing obligations.
The matching of assets and liability maturities lowers default risk.
An increase in the payables deferral period will lead to reduction in the need to non-spontaneous
funding.
Ans.
An increase in the payables deferral period will lead to reduction in the need to non-spontaneous
funding.
Which one of the following factors might cause a firm to increase the debt in its financial structure?
An increase in the corporate income tax rate.
Increased economic uncertainty.
An increase in the federal funds rate.
An increase in the price-earnings ratio.
Ans.
An increase in the corporate income tax rate.
Mojo Jojo Company is calculating it ratios relating to debt-paying ability for the year ended December 31,
20CY. Below is the relevant information:
Sales revenue
P325,000
Cost of goods sold and operating expenses
75,000
Interest expense
20,000
Income tax expense
6,000
Profit
9,000
12-31-CY
Cash
P 10,000
Accounts receivable
25,000
Inventory
45,000
Accounts payable
24,000
Taxes payable
11,000
The company uses 365 days in a year
What is Mojo’s time’s interest earned?
01-01-CY
P 16,000
15,000
60,000
28,000
13,000
12.50 16.25 3.750 11.50
Ans.
12.50
A debt-to-equity ratio is? CMA 0687 4-27
About the same as the debt-to-assets ratio.
Higher than the debt-to-assets ratio.
Lower than the debt-to-assets ratio.
Not correlated with the debt-to-assets ratio.
Ans.
Higher than the debt-to-assets ratio.
If the ratio of total liabilities to shareholders' equity increases, a ratio that must also increase is ? CMA
0685 4-17
Times interest earned.
Total liabilities to total assets.
Return on equity.
The current ratio.
Ans.
Total liabilities to total assets.
A company issued long-term bonds and used the proceeds to repurchase 40% of the outstanding shares
of its stock. This financial transaction will likely cause the?
CIA 1192 I
Total assets turnover ratio to increase.
Current ratio to decrease.
Times-interest-earned ratio to decrease.
Fixed charge coverage ratio to increase.
Ans.
Times-interest-earned ratio to decrease.
A company has the following income statements:
Year 2 Year 1
Sales $1,500,000
$1,400,000
Cost of goods sold
800,000
750,000
Gross profit
$ 700,000
$ 650,000
Selling & admin. Expense
62,000 60,000
Depreciation expense 50,000 50,000
Earnings before interest & taxes $ 688,000
$ 540,000
Interest expense
100,000
100,000
Earnings before taxes $ 588,000
$ 440,000
Income tax (50%)
294,000
220,000
Net income
$ 294,000
$ 220,000
Selected balance sheet items are as follows:
Year 2 Year 2
Year-end
Year-end
Accounts receivable
$300,000
Accounts payable
250,000
$200,000
275,000
Assume a 365-day year in any calculations. The company had an interest-coverage ratio in Year 1 of
2.20 times. 2.94 times. 5.40 times. 6.88 times.
Ans.
5.40 times.
If a company is profitable and is effectively using leverage, which one of the following ratios is likely to be
the largest?CMA 0690 4-18
Return on total assets.
Return on operating assets.
Return on common equity.
Return on total equity.
Ans.
Return on common equity.
When compared to a debt-to-asset ratio, a debt-to-equity ratio would?
Be lower than the debt-to-asset ratio.
Be higher than the debt-to-asset ratio.
Be about the same at the debt-to-asset ratio.
Have no relationship at all to the debt-to-asset ratio.
Ans.
Be higher than the debt-to-asset ratio.
A company has income after tax of P5.4 million, interest expense of P1 million for the year, depreciation
expense of P1 million, and a 40% tax rate. What is the company’s times-interest-earned ratio?
5.4 6.4 7.4 10.0
Ans.
5.4
In the process of investing of surplus cash, the term “riding the yield curve” refers to
Diversifying securities portfolio so that the firm has an equal balance of long-term versus short-term
securities.
Swapping different maturities of similar quality debt securities in order to obtain higher yield.
Purchasing only the longest maturities for given rates of return.
Adherence to the liquidity preference theory of securities investment.
Ans.
Swapping different maturities of similar quality debt securities in order to obtain higher yield.
Panga Company asked you to interpret the following ratios provided by its accountant on December 31,
20CY:
Acid-test ratio 1.2
Times interest earned 8
Gross margin ratio
40%
Inventory turnover
6
Debt-to-equity ratio
0.9 to 1
Ratio of operating expenses to sales
15%
Total shareholders’ equity on December 31, 20CY was P900,000. Gross margin for 20CY amounted to
P600,000. Beginning balance of merchandise inventory was P200,000. The company’s long-term
liabilities consisted of bonds payable with interest at 15%. You decided to reconstruct the company’s
financial statements based on the limited information given to serve as a basis for further analysis.
P312,500 P350,000 P400,000 P562,500
Ans.
P312,500
The following situations are descriptive of SBD Corporation. Which would be considered as the most
favorable for the ordinary shareholders?
Book value per share of ordinary shares is substantially higher than market value per share; return on
ordinary shareholders’ equity is less than the rate of interest paid to creditors.
Equity ratio is high; return on assets exceeds the cost of borrowing.
SBD stops paying dividends on its cumulative preference shares; the price earnings ratio of ordinary
shares is low.
Equity ratio is low; return on assets exceeds the cost of borrowing.
Ans.
Equity ratio is low; return on assets exceeds the cost of borrowing.
A measure of long-term debt-paying ability is a company's
Length of the operating cycle.
Return on assets.
Inventory turnover ratio.
CMA 0688 4-11
Times-interest-earned ratio.
Ans.
Times-interest-earned ratio.
The relationship of the total debt to the total equity of a corporation is a measure of?
Liquidity. Profitability. Creditor risk. Solvency.
Ans.
Creditor risk.
CMA 0688 4-21
Securing of funds for investment at a fixed rate of return to fund suppliers to enhance the well being of
the ordinary shareholders is known as:
Financial leverage.
Fund management.
Prudent borrowing.
Financial arbitrage.
Ans.
Financial leverage.
If the ratio of total liabilities to shareholders equity increases, a ratio that must would also increase is?
Time interest ratio
The current ratio.
Total liabilities to total assets.
Return on shareholders’ equity.
Ans.
Total liabilities to total assets.
The following information relates to Gold Corporation:
Gold Corporation
Selected Financial Data
For The Year Ended, December 31, 20CY
Operating profit
P 900,000
Interest expense
100,000
Profit before income tax
800,000
Income tax expense
320,000
Profit
480,000
Preference shares dividends
200,000
Profit available to ordinary shareholders
280,000
Ordinary shares dividends
120,000
Increase in retained earnings
P 160,000
The times preferred dividend earned ratio is?
1.4 to 1 1.7 to 1 2.4 to 1 s4.0 to 1
Ans.
2.4 to 1
Information that relates to a firm’s solvency is used primarily to assess a firm’s ability to
Convert assets to cash.
Pay its debts.
Generate profits.
Collect its receivables in a timely manner.
Ans.
Pay its debts.
The following information relates to Gold Corporation:
Gold Corporation
Selected Financial Data
For The Year Ended, December 31, 20CY
Operating profit
P 900,000
Interest expense
100,000
Profit before income tax
800,000
Income tax expense
320,000
Profit
480,000
Preference shares dividends
200,000
Profit available to ordinary shareholders
280,000
Ordinary shares dividends
120,000
Increase in retained earnings
P 160,000
The times interest earned ratio is
2.8 to 1 4.8 to 1 8.0 to 1 9.0 to 1
Ans.
9.0 to 1
You are requested to reconstruct the account of Global Link Supplies for analysis. The following data
were made available to you:
Gross margin for 20CY amounted to P472,500. Ending balance of merchandise inventory was P300,000.
Long-term liabilities consisted of bonds payable with interest rate of 20%. Total shareholders’ equity as
of December 31, 20CY was
P750,000.
Gross margin ratio
35%
Debt-to-equity ratio
0.8 to 1
Times interest earned
10
Quick ratio
Ratio of operating expenses to sales
How much was the bonds payable?
1.3 to 1
18%
P400,000 P200,750 P114,750 P370,500
Ans.
P114,750
The management of Melanie Corporation is preparing its plans for the year 20CY. The average assets to
be employed for the year are estimated at P2,600,000 with 20% of this amount borrowed at no interest
cost. Materials and labor cost for the year is budgeted at P4,000,000, while operating costs are
estimated at P1,500,000. All sales are to be billed at 162.5% of materials and labor cost. Income taxes
are at an average of 35% of Profit before income tax.
The expected asset turnover for 20CY is?
1.5 times 2.5 times 3.36 times 3.75 times
Ans.
2.5 times
A fire has destroyed many of the financial records of R. Son & Company. You are assigned to put together
a financial report. You have found the return on equity to be 12% and the debt ratio was 0.40. What was
the return on assets?
5.35% 8.4% 6.60% 7.20%
Ans.
7.20%
If the return on total assets is 10% and if the return on ordinary shareholders’ equity is 12% then.
The after-tax cost of long-term debt is probably greater than 10%.
The after-tax cost of long-term debt is 12%.
Leverage is negative.
The after-tax cost of long-term debt is probably less than 10%.
Ans.
The after-tax cost of long-term debt is probably less than 10%.
Return on investment (ROI) is a term often used to express income earned on capital invested in a
business unit. A company's ROI is increased if?
Sales increase by the same dollar amount as expenses and total assets.
Sales remain the same and expenses are reduced by the same dollar amount that total assets increase.
Sales decrease by the same dollar amount that expenses increase.
Net profit margin on sales increases by the same percentage as total assets.
Ans.
Sales remain the same and expenses are reduced by the same dollar amount that total assets increase.
Return on investment may be calculated by multiplying total asset turnover by
Average collection period.
Profit margin.
Debt ratio.
Fixed-charge coverage.
Ans.
Profit margin.
Blackmer Company had 80,000 shares of common stock outstanding as of December 1, Year 1, the
beginning of the company's fiscal year. The company also had $200,000 of 8% convertible bonds
outstanding that had been issued at $1,000 par. The bonds were convertible into 20,000 shares of
common stock. The Aa bond interest rate
has been 10% for several years, and the company's tax rate is 34%. The company's net income for the
year was $107,000, and no bonds were converted during the year. The fully diluted earnings per share
(rounded to the nearest cent) of Blackmer common stock for the fiscal year ended November 30, Year 2
was?
$1.18 per share. $1.07 per share. $1.20 per share. $1.23 per share.
Ans.
$1.18 per share.
Cebu Corporation’s books disclosed the following information as of and for the year ended December 31,
20CY:
Net credit sales
Net cash sales
Merchandise purchases
Inventory at beginning
Inventory at end
Accounts receivable at beginning
Accounts receivable at end
Profit
Marble’s percent of profit on sales is?
4% 9% 44% 56%
Ans.
4%
P2,000,000
500,000
1,000,000
600,000
200,000
300,000
700,000
100,000
The Intelinet Corporation and Comp Inc. have assets of $100,000 each and a return on common equity
of 17%. Intelinet has twice the debt of Comp Inc., while Comp has half the sales of Intelinet. If Intelinet
has net income of $10,000 and a total assets turnover ratio of 3.5, what is Comp Inc.'s profit margin?
3.31% 7.71% 10.00% 13.50%
Ans.
7.71%
Northern Division reported the following results for 20CY:
Annual sales
P500,000
Net earnings
80,000
Investment
250,000
What is Northern Division’s return on investment?
10% 16% 24% 32%
Ans.
32%
Global Corporation registered accelerated increase in its profit from P437,500 in 20PY to P1,260,000 in
20CY. Rate of return on current assets increased from 25% in 20PY to 30% in 20CY. Current asset
turnover, on the other hand, went up to 2.87 turnovers in 20CY from 2.45 turnovers in 20PY.
The cost of goods sold and operating expenses, including depreciation, in 20CY amounted to:
P10,794,000 P 5,022,500 P 6,022,500 P10,253,250
Ans.
P10,794,000
sSelected information for Bohol Corporation is as follows:
December 31
20PY 20CY
Preference shares
P180,000
P180,000
Ordinary shares 648,000
840,000
Retained earnings
192,000
360,000
Profit for year ended 144,000
240,000
What is Bohol’s rate of return on average shareholders’ equity for 20CY?
16.0% 20.0% 23.5% 26.0%
Ans.
20.0%
Associated Company paid out one-half of its 20PY earnings by dividends. Its earnings increased by 20%
and the amounts of its dividends increased by 15% in 20CY. Associated dividend payout ratio for 20CY
was
51.5% 52.3% 75.00% 47.90%
Ans.
47.90%
Selected information for Bohol Corporation is as follows:
December 31
20PY 20CY
Preference shares
P180,000
P180,000
Ordinary shares 648,000
840,000
Retained earnings
192,000
360,000
Profit for year ended 144,000
240,000
What is Bohol’s rate of return on average shareholders’ equity for 20CY?
16.0% 20.0% 23.5% 26.0%
Ans.
20.0%
The management of Melanie Corporation is preparing its plans for the year 20CY. The average assets to
be employed for the year are estimated at P2,600,000 with 20% of this amount borrowed at no interest
cost. Materials and labor cost for the year is budgeted at P4,000,000, while operating costs are
estimated at P1,500,000. All sales are to be billed at 162.5% of materials and labor cost. Income taxes
are at an average of 35% of Profit before income tax.
10.00% 12.50% 14.29% 27.86%
Ans.
10.00%
In the current year, Griffin Inc. had $15 million in sales, while total fixed costs were held to $6 million.
The firm's total assets at year-end were $20 million and the debt/equity ratio was calculated at 0.60. If
the firm's EBIT is $3 million, the interest on all debt is 9%, and the tax rate is 40%, what is the firm's
return on equity?
11.16% 14.4% 18.6% 24.0%
Ans.
11.16%
Peters Company has a 2-to-1 current ratio. This ratio would increase to more than 2 to 1 if ?
A previously declared stock dividend were distributed.
The company wrote off an uncollectible receivable.
The company sold merchandise on open account that earned a normal gross margin.
The company purchased inventory on open account.
Ans.
The company sold merchandise on open account that earned a normal gross margin.
Clik & Company has a debt ratio of 0.50, a total assets turnover of 0.25, and a profit margin of 10%. The
president is unhappy with the current return on equity, and he thinks it could be doubled. This could be
accomplished (1) by increasing the profit margin to 14% and (2) by increasing debt utilization. Total
assets turnover will not change. What new debt ratio, along with the 14% profit margin, is required to
double the return on equity?
0.75 0.70 0.65 0.55
Ans.
0.65
Which of the following is an appropriate computation for return on investment?
Income divided by total assets.
Income divided by sales.
Sales divided by total assets.
Sales divided by shareholders’ equity.
Ans.
Income divided by total assets.
Real Estates Corporation has shareholders’ equity equal to 60% of total liabilities and shareholders’
equity of P120 million. If the return on total assets invested registers at 9% what is the return on
shareholders’ equity?
10.00% 6.00% 15.00% 12.00%
Ans.
15.00%
Financial ratios, which assess the profitability of a company, include all of the following except the?
Dividend yield ratio.
Gross profit percentage.
Earnings per share ratio.
Return on sales ratio.
Ans.
Dividend yield ratio.
A company has common and preferred shares outstanding with the following characteristics:
Common Shares
Preferred Shares
Number of shares outstanding 50,000 25,000
Dividends paid during the year $100,000
$50,000
Year-end market price per share $10
$5
Book value of equity
$500,000
$250,000
For the year just ended, the company had the following statement of income:
Sales revenue $ 1,000,000
Cost of goods sold
300,000
Depreciation expense 100,000
Earnings before Interest and tax 600,000
Interest expense
100,000
Earnings before tax
500,000
Tax expense
250,000
Net income
$ 250,000
The company has earnings per share of?
$2.67 $3.33 $4.00 $5.00
Ans.
$4.00
White Knight Enterprises is experiencing a growth rate of 9% with a return on assets of 12%. If the debt
ratio is 36% and the market price of the stock is $38 per share, what is the return on equity?
7.68% 9.0% 12.0% 18.75%
Ans.
18.75%
What type of ratio is earnings per share?
Profitability ratio. Activity ratio. Liquidity ratio. Leverage ratio.
Ans.
Profitability ratio.
Which of the following ratios would most likely be used by management to evaluate short-term liquidity?
Return on total assets.
Sales to cash.
Accounts receivable turnover.
Acid-test ratio.
Ans.
Acid-test ratio.
MP Goods, Inc. has a total asset turnover of 0.30 and a profit margin of 10 percent. The president is
unhappy with the current return on assets; and he thinks it could be doubled. This could be
accomplished (1) by increasing the profit margin to 15 percent and (2) by increasing the total assets
turnover. What new asset turnover ratio, along with the 15 percent profit margin, is required to double
the return on assets?
35% 45% 40% 50%
Ans.
40%
This ratio of analytical measurement measures the productivity of assets regardless of capital structures?
Return on total assets. Quick ratio. Current ratio. Debt ratio.
Ans.
Return on total assets.
You are requested to reconstruct the account of Global Link Supplies for analysis. The following data
were made available to you:
Gross margin for 20CY amounted to P472,500. Ending balance of merchandise inventory was P300,000.
Long-term liabilities consisted of bonds payable with interest rate of 20%. Total shareholders’ equity as
of December 31, 20CY was
P750,000:
Gross margin ratio
35%
Debt-to-equity ratio
0.8 to 1
Times interest earned 10
Quick ratio
1.3 to 1
Ratio of operating expenses to sales
What is the operating profit for 20CY?
18%
P472,500 P243,000 P206,500 P229,500
Ans.
P229,500
Which of the following statements is incorrect?
Profitability evaluation ratios have a higher power than solvency determination ratios predicting for
performance for both income and solvency
Gross profit percentages do not vary a great deal among industries.
It is appropriate to compare a company’s current financial ratio with same financial ratio for (1) that
company is prior years and/or (2) the ratio for the industry in which the company is affiliated.
Companies where product costs present a high percentage of total costs could be expected to have a
low gross profit percentage.
Ans.
Gross profit percentages do not vary a great deal among industries.
Global Corporation registered accelerated increase in its profit from P437,500 in 20PY to P1,260,000 in
20CY. Rate of return on current assets increased from 25% in 20PY to 30% in 20CY. Current asset
turnover, on the other hand, went up to 2.87 turnovers in 20CY from 2.45 turnovers in 20PY.
The average investment in current assets of Global Corporation in 20CY was:
P2,975,000 P1,750,000 P4,200,000 P5,950,000
Ans.
P2,975,000
For the year ended May 31, Year 2, Cooper, Inc. had per share earnings of $4.80. Cooper's outstanding
stock for the Year 1-Year 2 fiscal year consisted of $2,000,000 of 10% preferred with $100 par value and
1,000,000 shares of common. On June 1, Year 2, the common stock split 3 for 1, and the company
redeemed one-half of the preferred stock at par value. Cooper's net income for the year ended May 31,
Year 3, was 10% higher than in Year 2. Earnings per share in Year 3 on Cooper's common stock were?
$1.76. $1.80. $5.28. $5.40.
Ans.
$1.80.
Panga Company asked you to interpret the following ratios provided by its accountant on December 31,
20CY:
Acid-test ratio
1.2
Times interest earned
8
Gross margin ratio
40%
Inventory turnover
6
Debt-to-equity ratio
0.9 to 1
Ratio of operating expenses to sales
15%
Panga’s operating profit in 20CY is:
P525,000 P300,000 P375,000 P225,000
Ans.
P375,000
The management of Melanie Corporation is preparing its plans for the year 20CY. The average assets to
be employed for the year are estimated at P2,600,000 with 20% of this amount borrowed at no interest
cost. Materials and labor cost for the year is budgeted at P4,000,000, while operating costs are
estimated at P1,500,000. All sales are to be billed at 162.5% of materials and labor cost. Income taxes
are at an average of 35% of Profit before income tax.
20.00% 25.00% 31.25% 40.50%
Ans.
25.00%
A company has common and preferred shares outstanding with the following characteristics:
Common Shares
Preferred Shares
Number of shares outstanding 50,000 25,000
Dividends paid during the year $100,000
$50,000
Year-end market price per share $10
$5
Book value of equity
$500,000
$250,000
For the year just ended, the company had the following statement of income:
Sales revenue $ 1,000,000
Cost of goods sold
300,000
Depreciation expense 100,000
Earnings before Interest and tax 600,000
Interest expense
100,000
Earnings before tax
500,000
Tax expense
250,000
Net income
$ 250,000
The company has a rate of return on common equity of?
26.67% 33.33% 40.00% 50.00%
Ans.
40.00%
December 31
20PY
20CY
Preference shares
P 180,000
P 180,000
Ordinary shares
648,000
840,000
Retained earnings
192,000
360,000
Profit for the year ended
144,000
240,000
What is Brain’s rate of return on average shareholders’ equity for 20CY?
16.0% 20.0% 23.5% 26.0%
Ans.
20.0%
Selected information for Palawan Company is as follows:
December 31
20PY 20CY
Preference shares, 8%, par P100, nonconvertible, noncumulativeP125,000
Ordinary shares 300,000
400,000
Retained earnings
75,000 185,000
Profit 91,200 120,000
Dividends paid on preference shares for the year ended 50,000 43,200
P125,000
Palawan Company’s return on ordinary shareholders’ equity, rounded to the nearest percentage point,
for 20CY is?
16% 19% 32% 25%
Ans.
16%
A major problem in comparing profitability measures among companies is the?
Lack of general agreement over which profitability measure is best.
Differences in the size of the companies.
Differences in the accounting methods used by the companies.
Differences in the dividend policies of the companies.
Ans.
Differences in the accounting methods used by the companies.
The book value per share calculation of a corporation is usually significantly different from the market
value of the stock's selling price due to the?
Use of accrual accounting in preparing financial statements.
Omission of the number of preferred shares outstanding at year-end in the calculation.
Use of historical costs in preparing financial statements.
Omission of total assets from the numerator in the calculation.
Ans.
Use of historical costs in preparing financial statements.
Information concerning the Snake Company’s ordinary shares is as follows:
Per share
Book value at December 31, 20CY
P 12
Quoted market value on Philippine Stock Exchange on December 31, 2018
9
Earnings for 20CY
3
Par value
2
Dividend for 20CY
1
What was the price-earnings ratio on ordinary shares for 20CY?
2.00 to 1 2.67 to 1 3.00 to 1 4.00 to 1
Ans.
3.00 to 1
An increase in the market price of a company's common stock will immediately affect its..
Dividend yield.
Debt-to-equity ratio.
Earnings per share.
Dividend payout ratio.
Ans.
Dividend yield.
Watson Corporation computed the following items from its financial records for the year:
Price-earnings ratio
Payout ratio
.6
Asset turnover ratio
12
.9
The dividend yield on Watson's common stock is?
5.0% 7.2% 7.5% 10.8%
Ans.
5.0%
At December 31, 20CY, Continental Corporation had 100,000 shares of P10 par value ordinary shares
issued and outstanding. There was no change in the number of shares outstanding during 20PY. Total
shareholders’ equity at December 31, 20CY was P2,800,000. The profit for the year ended December 31,
20CY was P800,000. During 20CY, Continental paid P3 per share in dividends on its ordinary shares. The
quoted market value of Continental’s ordinary shares on the Philippine Stock Exchange was P24 on
December 31, 20CY. What was the price-earnings ratio on ordinary shares for 20CY?
3.0 to 1 3.5 to 1 4.8 to 1 8.0 to 1
Ans.
3.0 to 1
Given a year’s end profit of P1.5 million and 50,000 ordinary shares outstanding throughout the year
with market price per share at year’s being P120, the price-earnings ratio is:
2 times 3 times 4 times 5 times
Ans.
4 times
Cyclone Corporation was authorized to issue 1,000 shares of P100 par, 8% cumulative preference shares
and 100,000 shares of P100 par ordinary shares. The equity account balances at December 31, 20CY are
as follows:
Cumulative preference shares
Ordinary shares
Share premium
Retained earnings
Treasury stock, common – 100 shares at cost
Total
P 50,000
90,000
9,000
13,000
( 2,000)
P160,000
Dividends on preference shares are in arrears for the year 20CY. The book value of a share of ordinary
shares at December 31, 20CY should be?
P132.50 P127.50 P117.78 P122.22
Ans.
P127.50
Which one of the following statements about the price-earnings (P-E) ratio is correct?
A company with high growth opportunities ordinarily has a high P-E ratio.
A P-E ratio has more meaning when a firm has losses than when it has profits.
A P-E ratio has more meaning when a firm has abnormally low profits in relation to its asset base.
A P-E ratio expresses the relationship between a firm's market price and its net sales.
Ans.
A company with high growth opportunities ordinarily has a high P-E ratio.
The following information is provided about the common stock of Evergreen Inc. at the end of the fiscal
year:
Number of shares outstanding 1,800,000
Par value per share
$ 10.00
Dividends paid per share (last 12 months)
Market price per share 108.00
Basic earnings per share36.00
Diluted earnings per share
24.00
12.00
The price-earnings ratio for Evergreen's common stock is?
3.0 times. 4.5 times. 9.0 times. 10.8 times.
Ans.
3.0 times.
Perry Company was organized on January 2, 20CY, with the following capital structure:
10% cumulative preference shares, par value P100 and liquidation value, P105;
authorized, issued and outstanding, 1,000 shares
P 100,000
Ordinary shares, par value P25, authorized 100,000 shares; issued and
outstanding 10,000 shares
P 250,000
Perry’s profit for the year ended December 31, 20CY, was P450,000, but no dividends were declared.
How much was Perry’s book value per ordinary share at December 31, 20CY?
P45.00 P68.50 P69.50 P70.00
Ans.
P68.50
The company issued new ordinary shares in a three-for-one stock split. Identify the statements that
indicate the correct effect(s) of this transaction.
1.
It reduces equity per share of ordinary shares.
2.
Share of each ordinary shareholder is reduced.
3.
The peso amount of capital stock is increased.
4.
Working capital and current ratio are increased.
Statements 1 and 4 only are correct.
Statement 1 only is correct.
All four statements are correct.
Statements 3 and 4 only are correct.
Ans.
Statement 1 only is correct.
The following information pertains to AL Corporation as of and for the year ended December 31, 20CY:
Liabilities
P 60,000
Shareholders’ equity
P 500,000
Ordinary shares issued and outstanding
10,000 shares
Profit
P 30,000
During 20CY, AL officers exercised stock options for 1,000 shares of stock at an option price of P8 per
share. What was the effect of exercising the stock option?
No ratios were affected
Assets turnover increased to 5.4%
Debt to equity ratio decreased to 12%.
Earnings per share increased by P0.33.
Ans.
Debt to equity ratio decreased to 12%.
How are the dividends per share for ordinary shares used in the calculation of the following?
Dividend payout ratio
Earnings per share
Denominator
Denominator
Numerator
Numerator
Ans.
Numerator
Denominator
Not used
Not used
Numerator
Not used
The following data pertain to Marina Company for the calendar year 20CY:
Sales (on credit)P2,000,000
Gross profit on sales
900,000
Profit 150,000
Purchases
1,000,000
Inventory at the end of year
250,000
Accounts receivable at beginning of year
600,000
Accounts receivable at end of year
400,000
Shareholders’ equity at the end of year:
Ordinary shares outstanding (unchanged
during the year) -- 30,000 shares at
par of P1 per share
P300,000
Retained earnings
500,000 800,000
2.0 to 1 2.5 to 1 10.0 t0 20.0 to 1
Ans.
10.0 t0
How are the following used in the calculation of the dividend payout ratio for a company with only
ordinary shares outstanding?
Dividends
Earnings
Book value
per share
per share
per share
Denominator
Denominator
Numerator
Numerator
Ans.
Numerator
Numerator
Not used
Denominator
Not used
Not used
Denominator
Not used
Numerator
Not used
Denominator
Baylor Company paid out one-half of last year's earnings in dividends. Baylor's earnings increased by
20%, and the amount of its dividends increased by 15% in the current year. Baylor's dividend payout
ratio for the current year was
50% 57.5% 47.9% 78%
Ans.
47.9%
Information concerning Hamilton's common stock is presented below for the fiscal year ended May 31,
Year 2.
Common shares outstanding 750,000
Stated value per share $ 15.00
Market price per share 45.00
Year 1 dividends paid per share 4.50
Year 2 dividends paid per share 7.50
Primary earning per share
11.25
Fully diluted earnings per share 9.00
The price-earnings ratio for Hamilton's common stock is?
3.0 times.
4.0 times. 5.0 times. 6.0 times.
Ans.
5.0 times.
Perry Company was organized on January 2, 20CY, with the following capital structure:
10% cumulative preference shares, par value P100 and liquidation value, P105;
authorized, issued and outstanding, 1,000 shares
P 100,000
Ordinary shares, par value P25, authorized 100,000 shares; issued and
outstanding 10,000 shares
250,000
Perry’s profit for the year ened December 31, 20CY, was P450,000, but no dividends were declared.
How much was Perry’s book value per preference share at December 31, 20CY?
P100 P105 P110 P115
Ans.
P115
Makati Corporation’s current balance sheet reports the following shareholders’ equity balances:
5% cumulative preference shares,
P100 par value, 2,500 shares issued and outstanding
P 250,000
Ordinary shares, P3.50 par value,
100,000 shares issued and outstanding 350,000
Additional paid-in-capital
125,000
Retained earnings
300,000
Dividends in arrears on the preference shares amount to P25,000. If Makati were to be liquidated, the
preference shareholders would receive par value plus a premium of P50,000. The book value per share
of ordinary shares is?
P7.75 P7.50 P7.25 P7.00
Ans.
P7.00
Information concerning the common stock of Morris Company as of November 30, the end of the
company's current fiscal year, is presented below.
Number of shares outstanding 460,000
Par value per share
$ 5.00
Dividends paid per share in current year 6.00
Market price per share 54.00
Primary earnings per share
18.00
Fully diluted earnings per share 12.00
The price-earnings ratio for Morris Company's common stock is?
10.8 times. 3.0 times. 9.0 times. 4.5 times.
Ans.
4.5 times.
Andy Corporation’s shareholders’ equity at December 31, 20CY, consisted of the following;
Preference shares, P50 par value, 10% noncumulative;
10,000 shares issued and outstanding
P 500,000
Ordinary shares, P10 par value; 80,000 shares issued and outstanding
800,000
Retained earnings
300,000
The preference share has a liquidating value of P55 per share. At December 31, 20CY, the book value
per ordinary share is?
P14.38 P13.75 P13.13 P10.00
Ans.
P13.13
The following data pertain to ABC Corporation for the calendar year 20CY:
Profit
P 240,000
Dividends paid on ordinary shares
P 120,000
Ordinary shares outstanding (unchanged during the year)
300,000 shares
The market price per share of ABC’s ordinary shares at December 31, 20CY was P12. The price- earnings
ratio at December 31, 20CY was?
9.6 to 1 10.0 to 1 15.0 to 1 30.0 to 1
Ans.
15.0 to 1
On December 31, 20PY and 20CY, Simon Company had 100,000 shares of ordinary shares and 50,000
shares of non-cumulative and non-convertible preference shares issued and outstanding. Additional
information is as follows:
Shareholders’ equity at December 31, 20CY
P4,500,000
Profit for the year ended December 31, 20CY
1,200,000
Dividends on preference shares for the year ended, December 31, 20CY
300,000
Market price per share ordinary shares at December 31, 20CY
72
The price-earnings ratio on ordinary shares at December 31, 20CY was?
5 to 1 6 to 1 8 to 1 9 to 1
Ans.
8 to 1
A drop in the market price of a firm's common stock will immediately increase its
Return on equity.
Dividend payout ratio.
Market-to-book ratio.
Dividend yield.
Ans.
Dividend yield.
An increase in the market price of a company's common stock will immediately affect its?
Dividend yield.
Debt-to-equity ratio.
Earnings per share.
Dividend payout ratio.
Ans.
Dividend yield.
Markham's total shareholders' equity would be?
Increased by the dividend declaration and unchanged by the dividend payment.
Unchanged by the dividend declaration and decreased by the dividend payment.
Unchanged by either the dividend declaration or the dividend payment.
Decreased by the dividend declaration and unchanged by the dividend payment.
Ans.
Decreased by the dividend declaration and unchanged by the dividend payment.
Book value per common share represents the amount of equity assigned to each outstanding share of
common stock. Which one of the following statements about book value per common share is correct?
Market price per common share usually approximates book value per common share.
Book value per common share can be misleading because it is based on historical cost.
A market price per common share that is greater than book value per common share is an indication of
an overvalued stock.
Book value per common share is the amount that would be paid to shareholders if the company were
sold to another company.
Ans.
Book value per common share can be misleading because it is based on historical cost.
For a company that has only ordinary shares outstanding, total shareholders’ equity divided by the
number of shares outstanding represents the:
Return on equity
Stated value per share
Book value per share
Price-earnings ratio
Ans.
Book value per share
Mr. Kenobi, the owner of Galactic Company is arguing with his accountant as to the best measure of
liquidity. He was considering the following and you are to advise him which one is the best. Which one
will you choose?
Current assets minus inventories to current liabilities.
Total assets minus goodwill to total liabilities.
Profit minus dividends to interest expense.
Sales minus returns to total debt.
Ans.
Current assets minus inventories to current liabilities.
FMA Inc.’s financial statements as the year ended December 31, 20CY show accounts receivables, net of
P750,000 and sales at P15 million. Accounts receivable remained relatively constant during the year.
OMB’s accounts receivable turnover in days is:
18.25 20.25 15.25 16.25
Ans.
18.25
On December 31, 20CY, Pagudpod Company collected a receivable due from a major customer. Which of
the following ratios would be increased by this transaction?
Inventory turnover ratio
Quick ratio.
Receivable turnover ratio.
Current ratio.
Ans.
Receivable turnover ratio.
The following data pertain to Marina Company for the calendar year 20CY:
Sales (on credit)P2,000,000
Gross profit on sales
900,000
Profit
150,000
Purchases
1,000,000
Inventory at the end of year
250,000
Accounts receivable at beginning of year
600,000
Accounts receivable at end of year
400,000
Shareholders’ equity at the end of year:
Ordinary shares outstanding (unchanged
during the year) -- 30,000 shares at
par of P1 per share
P300,000
Retained earnings
500,000 800,000
Dividends paid during the year totaled P0.25 per share. The market price per share of Marina’s stock was
P5 at the end of the year.
Marina’s accounts receivable turnover for 20CY was?
1.8 times 2.0 times. 4.0 times 5.0 times
Ans.
4.0 times
The following information was taken from the income statement of Hadley co.:
Beginning inventory
17,000
Purchases
56,000
Ending inventory
13,000
What is Hadley Co.’s inventory turnover?
3. 4. 5. 6.
Ans.
4.
Selected information from the Beta Company’s accounting records is as follows:
Net accounts receivable at December 31, 20PY
P 900,000
Net accounts receivable at December 31, 20CY
1,000,000
Inventories, December 31, 20PY
1,100,000
Inventories, December 31, 20CY
1,200,000
Accounts receivable turnover
5 to 1
Inventory turnover
4 to 1
What was Beta Company’s gross margin for 20CY?
P150,000 P200,000 P300,000 P400,000
Ans.
P150,000
A condensed comparative balance sheet for a company appears below:
12/31/Year 1 12/31/Year 2
Cash $ 40,000
$ 30,000
Accounts receivable
120,000
100,000
Inventory
200,000
300,000
Property, plant, & equipment 500,000
550,000
Accumulated depreciation
(280,000)
(340,000)
Total assets
$ 580,000
$ 640,000
Current liabilities
Long-term liabilities
Stockholders' equity
$ 60,000
390,000
130,000
$ 100,000
420,000
120,000
Total liabilities and equity
$ 580,000
$ 640,000
In looking at liquidity ratios at both balance sheet dates, what happened to the (1) current ratio and (2)
acid-test (quick) ratio?
1) Current Ratio
2) Acid-Test Ratio
1) Increased
1) Increased
1) Decreased
1) Decreased
Ans.
1) Decreased
2)
2)
2)
2)
Increased
Decreased
Increased
Decreased
2) Decreased
The collection of a current accounts receivable of $29,000 would
Increase the current ratio.
Decrease the current ratio and the quick ratio.
Increase the quick ratio.
Not affect the current or quick ratios.
Ans.
Not affect the current or quick ratios.
Windham Company has current assets of $400,000 and current liabilities of $500,000. Windham
Company's current ratio would be increased by
The purchase of $100,000 of inventory on account.
The payment of $100,000 of accounts payable.
The collection of $100,000 of accounts receivable.
Refinancing a $100,000 long-term loan with short-term debt.
Ans.
The purchase of $100,000 of inventory on account.
The following selected financial data were taken from the accounting records of Melanie Corporation:
Melanie Corporation
Selected Financial Data
December 31
20CY 20PY
Cash P170,000
90,000
Accounts receivable(net)
450,000
400,000
Merchandise inventory 540,000
420,000
Short-term marketable securities
80,000 40,000
Land and building (net) 1,000,000
1,000,000
Mortgage payable- current portion
60,000 50,000
Accounts payable and accrued liabilities 240,000
220,000
Short-term notes payable
100,000
140,000
Net credit sales totaled to P3,000,000 and P2,000,000 for the years ended December 31, 20PY and 20CY,
respectively.
At December 31, 20CY, Melanie’s current ratio was?
1.50 to 1.00 1.75 to 1.00. 2.06 to 1.00 3.10 to 1.00
Ans.
3.10 to 1.00
Which of the following ratios measures short-term solvency?
Current ratio.
Age of receivables.
Creditors’ equity to total assets.
Return on investment.
Ans.
Current ratio.
Which one of the following is not used in determining the operating cycle of an entity?
Accounts payable conversion
Inventory conversion cycle.
Fixed asset conversion cycle.
Cash conversion cycle.
Ans.
Fixed asset conversion cycle.
Mojo Jojo Company is calculating it ratios relating to debt-paying ability for the year ended December 31,
20CY. Below is the relevant information:
Sales revenue P325,000
Cost of goods sold and operating expenses
Interest expense
20,000
Income tax expense
6,000
Profit
9,000
75,000
12-31-CY
01-01-CY
Cash P 10,000
P 16,000
Accounts receivable
25,000
15,00
Inventory
45,000
60,000
Accounts payable
24,000
28,000
Taxes payable
11,000
13,000
The company uses 365 days in a year.
What is the amount of Mojo’s working capital at December 31, 20CY?
P41,000 P45,000 P50,000 P91,000
Ans.
P45,000
Efem Corporation made a substantial one time sale to a provincial based customer which was on credit
and had been outstanding for six months. Before the company could refer the account to a lawyer for
collection, the customer paid in full. Which of the following ratios would be increased by the unexpected
receipt?
Acid-test ratio
Receivable turnover ratio
Current ratio
Inventory turnover ratio
Ans.
Receivable turnover ratio
You are requested to reconstruct the account of Global Link Supplies for analysis. The following data
were made available to you:
Gross margin for 20CY amounted to P472,500. Ending balance of merchandise inventory was P300,000.
Long-term liabilities consisted of bonds payable with interest rate of 20%. Total shareholders’ equity as
of December 31, 20CY was
P750,000.
Gross margin ratio
35%
Debt-to-equity ratio
0.8 to 1
Times interest earned 10
Quick ratio
1.3 to 1
Ratio of operating expenses to sales
Total current assets would amount to
18%
P630,825 P780,000 P580,000 P930,825
Ans.
P930,825
The early liquidation of a long-term note with cash affects the
Current ratio to a greater degree than the quick ratio.
Quick ratio to a greater degree than the current ratio.
Current and quick ratio to the same degree.
Current ratio but not the quick ratio.
Ans.
Quick ratio to a greater degree than the current ratio.
All of the following statements are valid, except.
The short-term creditor is more interested in cash flow and in working capital management than he is in
how much accounting profit is reported.
If the return on total assets is higher than the after-tax cost of long-term debt then leverage is positive,
and the ordinary shareholders will benefit
The results of financial statements analysis are of value only when viewed in comparison with the
results of other periods or other firms.
The inventory turnover is computed by dividing sales by average inventory.
Ans.
The inventory turnover is computed by dividing sales by average inventory.
In computing inventory turnover, the preferred base to use is the
Sales base because it is more likely to reflect a change in trend.
Sales base because it provides turnover rates that are considerably higher.
Cost of sales base because it is not affected by the method used to value inventory.
Cost of sales base because it eliminates any changes due solely to sales price changes.
Ans.
Cost of sales base because it eliminates any changes due solely to sales price changes.
Accounts receivable turnover ratio will normally decrease as a result of
The write-off of an uncollectible account (assume the use of the allowance for doubtful accounts
method).
A significant sales volume decrease near the end of the accounting period.
An increase in cash sales in proportion to credit sales.
A change in credit policy to lengthen the period for cash discounts.
Ans.
A change in credit policy to lengthen the period for cash discounts.
RUS Inc. has the following data as at year ending December 31, 20CY:
Total assets
P5,000,000
Ordinary shares outstanding
2,500,000
Preference shares outstanding 1,000,000
Profit 750,000
Depreciation expense 500,000
There were no changes in number of shares outstanding during the year, AMK’s ratio of cash flow to
total liabilities is:
30% 50% 20% 60%
Ans.
60%
All of the following financial indicators are measures of liquidity and activity except the
Average collection period in days.
Merchandise inventory turnover.
Accounts receivable turnover.
Times-interest-earned ratio.
Ans.
Times-interest-earned ratio.
During 20CY, Lilia Company purchased P960,000 of inventory. The cost of goods sold for 20CY was
P900,000, and the ending inventory at December 31, 20CY was P180,000. What was the inventory
turnover for 20CY?
6.4 6.0 5.3 5.0
Ans.
6.0
Which of the outcomes represented in the following table would result from a company's retirement of
debt with excess cash
Following:
1) Total Assets Turnover Ratio
2) Period's Interest-Earned Ratio
1)
1)
1)
1)
Increase
Increase
Decrease
Decrease
2)
2)
2)
2)
Increase
Decrease
Increase
Decrease
Ans.
1) Increase
2) Increase
Given an acid test ratio of 2.0, current assets of $5,000, and inventory of $2,000, the value of current
liabilities is
$1,500 $2,500 $3,500 $6,000
Ans.
$1,500
Lan Company has a current ratio of 2 to 1. This ratio will decrease if the company?
Receives a 5% stock dividend on one of its marketable securities.
Pays a large account payable which had been a current liability.
Borrows cash on a six-month note.
Sells merchandise for more than cost and records the sale using the perpetual inventory method.
Ans.
Borrows cash on a six-month note.
The ratio of sales to working capital is a measure of?
Collectibility. Operational leverage Liquidity. Financial leverage.
Ans.
Liquidity.
December 31, 20CY, Allan Company collected a receivable due from a major customer. Which of the
following ratios would be increased by this transaction?
Inventory turnover ratio. Quick ratio. Receivable turnover ratio. Current ratio.
Ans.
Receivable turnover ratio.
Mojo Jojo Company is calculating it ratios relating to debt-paying ability for the year ended December 31,
20CY8. Below is the relevant information:
Sales revenue
P325,000
Cost of goods sold and operating expenses
Interest expense
20,000
Income tax expense
6,000
Profit
9,000
Cash
12-31-CY
P 10,000
01-01-CY
P 16,000
75,000
Accounts receivable
25,000
15,000
Inventory
45,000
60,000
Accounts payable
24,000
28,000
Taxes payable 11,000
13,000
The company uses 365 days in a year.
What is Mojo’s average collection period for accounts receivable in 20CY?
22.15 days 22.46 days 16.25 days. 13.00 days
Ans.
22.46 days
The following selected financial data were taken from the accounting records of Melanie Corporation:
Melanie Corporation
Selected Financial Data
December 31
20CY 20PY
Cash P170,000
90,000
Accounts receivable(net)
450,000
400,000
Merchandise inventory 540,000
420,000
Short-term marketable securities
80,000 40,000
Land and building (net) 1,000,000
1,000,000
Mortgage payable- current portion
60,000 50,000
Accounts payable and accrued liabilities 240,000
220,000
Short-term notes payable
100,000
140,000
Net credit sales totaled to P3,000,000 and P2,000,000 for the years ended December 31, 20PY and 20CY,
respectively.
At December 31, 20PY, Melanie’s quick (acid) test ratio was?
1.50 to 1.00. 1.75 to 1.00. 2.06 to 1.00. 3.10 to 1.00.
Ans.
1.75 to 1.00.
Selected information from the accounting records of Debbie Company is as follows:
Net sales for 20CY
P 1,800,000
Cost of goods sold for 20CY
1,200,000
Inventories at December 31, 20PY
336,000
Inventories at December 31, 20CY
288,000
Assuming there are 300 working days per year, what is the number of days’ sales in average inventories
for 20CY?
78 72 52 48
Ans.
78
The issuance of serial bonds in exchange for an office building, with the first instalment of the bonds due
late this year,
Decreases net working capital.
Decreases the current ratio.
Decreases the quick ratio.
Affects all of the answers as indicated.
Ans.
Affects all of the answers as indicated.
Selected data taken from the financial statements of Johnny Company for the year indicated:
20PY 20CY 20NY
Accounts receivable, net
Inventory
40,000 50,000
Current assets 120,000
Total assets, net700,000
Current liabilities
70,000
Cash sales
400,000
Credit sales
120,000
Costs of sales 310,000
P40,000
45,000
140,000
750,000
80,000 50,000
420,000
125,000
324,000
P42,500
P45,000
130,000
725,000
450,000
131,250
345,000
(Use 360 days in a year)
What is the working capital turnover for 20CY?
7.15 8.3 9.9 9.0
Ans.
8.3
The following data pertain to Marina Company for the calendar year 20CY:
Sales (on credit)P2,000,000
Gross profit on sales
900,000
Profit
150,000
Purchases
1,000,000
Inventory at the end of year
250,000
Accounts receivable at beginning of year
600,000
Accounts receivable at end of year
400,000
Shareholders’ equity at the end of year:
Ordinary shares outstanding (unchanged
during the year) -- 30,000 shares at
par of P1 per share
P300,000
Retained earnings
500,000
800,000
Dividends paid during the year totaled P0.25 per share. The market price per share of Marina’s stock was
P5 at the end of the year.
Marina’s inventory turnover for 20CY was?
2.0 times 2.2 times 4.4 times. 3.0 times
Ans.
4.4 times.
Inventory turnover indicates:
How many times in the course of a year the company is able to sell the amount of its average inventory.
The flow assumption, which provides the most current valuation in the balance sheet. The average time
period between the purchase of inventory and conversion of this inventory back to cash.
A pattern of transferring unit cost from the inventory account to the cost of goods sold.
Ans.
How many times in the course of a year the company is able to sell the amount of its average inventory.
Selected information from the operating records of Kay Company is as follows:
Net sales
P1,800,000
Cost of goods sold for 20CY
1,200,000
Inventory at 12/31/PY 360,000
Inventory at 12/31/CY 312,000
Kay’s inventory turnover for 20CY is
3.57 times 3.85 times 5.36 times 5.77 times
Ans.
3.57 times
Beatnik Company has a current ratio of 2.5 and a quick ratio of 2.0. If the firm experienced $2 million in
sales and sustains an inventory turnover of 8.0, what are the firm's current assets?
$1,000,000 $500,000 $1,500,000 $1,250,000
Ans.
$1,250,000
Which of the following statements is correct?
An increase in a firm’s inventories will call for additional financing unless the increase is offset by an
equal or larger decrease in some other asset account.
A high quick ratio is always a good indication of a well-managed liquidity position.
A relatively low return on assets (ROA) is always an indicator of managerial incompetence.
A high degree of operating leverage lowers the risk by stabilizing the firm’s earnings stream.
Ans.
An increase in a firm’s inventories will call for additional financing unless the increase is offset by an
equal or larger decrease in some other asset account.
The Irwin Corporation has $3 million per year in credit sales. The company's average day's sales
outstanding is 40 days. Assuming a 360-day year, what is Irwin's average amount of accounts receivable
outstanding?
$500,000 $333,333 $250,000 $75,000
Ans.
$333,333
Mendez Corporation discloses the following in relation to its financial statements for 20CY:
Cash P 37,500
Plant and equipment
441,000
Total assets
648,000
Income tax payable
37,500
Ordinary shares 450,000
Gross margin for 20CY 450,000
Accounts receivable, inventory, accounts payable,
long-term debt, and retained earnings
Total liabilities divided by total shareholders’ equity
Inventory turnover based on sales and ending inventory
Inventory turnover based on cost of goods sold and
ending inventory
Current ratio, at year-end
What was the balance in retained earnings?
P( 90,000) P 90,000 P(132,000) P 132,000
Ans.
P( 90,000)
?
0.8
15 times
10.5 times
1.5 to 1
Selected data from Perry Corporation's year-end financial statements are as follows.
Current ratio
Quick ratio
2.0
1.5
Current liabilities
$120,000
Inventory turnover(using a cost of sales base)
Gross profit margin
40%
8 times
Perry Corporation's net sales for the year were
What is the company's acid test (quick) ratio?
0.68 1.68 2.14 2.31
Ans.
2.14
Mendez Corporation discloses the following in relation to its financial statements for 20CY:
Cash P 37,500
Plant and equipment
441,000
Total assets
648,000
Income tax payable
37,500
Ordinary shares 450,000
Gross margin for 20CY 450,000
Accounts receivable, inventory, accounts payable,
long-term debt, and retained earnings
?
Total liabilities divided by total shareholders’ equity
0.8
Inventory turnover based on sales and ending inventory
15 times
Inventory turnover based on cost of goods sold and
ending inventory
10.5 times
Current ratio, at year-end
1.5 to 1
The balance in the inventory account is?
P 30,000 P 45,000 P100,000 P135,000
Ans.
P100,000
What will happen to the ratios below if CPZ Enterprises uses cash to pay 50% of the accounts payable?
Current Ratio
Quick Ratio
Increase
Increase
Decrease
Decrease
Increase
Decrease
Decrease
Increase
Ans.
Increase
Increase
Wall Corporation’s books disclosed the following information as of and for the year ended December 31,
20CY:
Net credit sales P3,000,000
Net cash sales 480,000
Accounts receivable at beginning
400,000
Accounts receivable at ending 800,000
Wall’s accounts receivable turnover is?
3.75 times 4.35 times 5.00 times 5.80 times
Ans.
5.00 times
Panga Company asked you to interpret the following ratios provided by its accountant on December 31,
20CY:
Acid-test ratio 1.2
Times interest earned 8
Gross margin ratio
40%
Inventory turnover
6
Debt-to-equity ratio
0.9 to 1
Ratio of operating expenses to sales
15%
Total shareholders’ equity on December 31, 20CY was P900,000. Gross margin for 20CY amounted to
P600,000. Beginning balance of merchandise inventory was P200,000. The company’s long-term
liabilities consisted of bonds payable with interest at 15%. You decided to reconstruct the company’s
financial statements based on the limited information given to serve as a basis for further analysis.
P462,500 P497,500 P504,500 P810,000
Ans.
P497,500
Obsolete inventory of $125,000 was written off during the year. This transaction
Decreased the quick ratio.
Increased the quick ratio.
Increased net working capital.
Decreased the current ratio.
Ans.
Decreased the current ratio.
Short-term creditors would probably be most interested in which ratio?
Current ratio Earnings per share. Debt-to-equity ratio. Quick ratio.
Ans.
Current ratio
Spurs Corporation has an acid test ratio 1.5 to 1.0. Which of the following will cause this ratio to
deteriorate?
Payment of cash dividends previously declared.
Borrowing short-term loan from a bank.
Sale of inventory on account.
Sale of equipment at a loss.
Ans.
Borrowing short-term loan from a bank.
FTA Corporation has a 2 to 1 current ratio. This ratio would increase more than 2 to 1 if
The company wrote off an uncollectible receivable.
The company purchased inventory on open account.
The company sold merchandise on open account that earned a normal gross margin.
Previously declared stock dividends were distributed.
Ans.
The company sold merchandise on open account that earned a normal gross margin.
Based on the data presented below, what is Beta Corporation's cost of sales for the year?
Current ratio 3.5
Acid test ratio 3.0
Year-end current liabilities
$600,000
Beginning Inventory
$500,000
Inventory turnover
8.0
$1,600,000 $2,400,000 $3,200,000 $6,400,000
Ans.
$3,200,000
A service company's working capital at the beginning of January of the current year was $70,000. The
following transactions occurred during January:
Performed services on account $ 30,000
Purchased supplies on account 5,000
Consumed supplies
4,000
Purchased office equipment for cash
2,000
Paid short-term bank loan
6,500
Paid salaries
10,000
Accrued salaries
3,500
What is the amount of working capital at the end of January?
$90,000 $80,500 $50,500 $47,500
Ans.
$80,500
Bond Corporation has a current ratio of 2 to 1 and a quick ratio (acid test) of 1 to 1. A transaction that
would change Bond's quick ratio but not its current ratio is the
Sale of inventory on account at cost.
Collection of accounts receivable.
Payment of accounts payable.
Purchase of a patent for cash.
Ans.
Sale of inventory on account at cost.
The ratio that measures a firm’s ability to generate earnings from its resources is?
Days’ sales in inventory
Asset turnover.
Sales to working capital.
Days’ sales in receivables.
Ans.
Asset turnover.
Sherlock Company’s net accounts receivable were P250,000 at December 31, 20PY, and P300,000 at
December 31, 20CY. The accounts receivable turnover for 20CY was 5.0. What were Sherlock’s total net
sales for 20CY?
P1,375,000 P1,500,000 P1,600,000 P2,750,000
Ans.
P1,375,000
Cyco, Inc. determined the follow concerning its operating activities:
Accounts receivable conversion cycle
18 days
Accounts payable conversion cycle
21 days
Inventory conversion cycle
24 days
Which one of the following is the length Cyco's cash cycle?
42 days. 39 days. 21 days. 15 days.
Ans.
21 days.
Assume net credit sales and cost of goods sold for Year 2 were $300,000 and $220,000, respectively. The
accounts receivable and inventory balances are as follows
Beginning
Ending
Accounts receivable
P45,000
Inventory
60,000 50,000
P30,000
Lisa, Inc.'s average collection period for Year 2, using a 360-day year, was?
36 days. 45 days. 54 days. 61 days.
Ans.
45 days.
Mendez Corporation discloses the following in relation to its financial statements for 20CY:
Cash P 37,500
Plant and equipment
441,000
Total assets
648,000
Income tax payable
37,500
Ordinary shares 450,000
Gross margin for 20CY 450,000
Accounts receivable, inventory, accounts payable,
long-term debt, and retained earnings
Total liabilities divided by total shareholders’ equity
Inventory turnover based on sales and ending inventory
Inventory turnover based on cost of goods sold and
ending inventory
Current ratio, at year-end
What was the balance in trade accounts payable?
P169,500 P138,000 P100,500 P207,000
Ans.
P100,500
?
0.8
15 times
10.5 times
1.5 to 1
Mojo Jojo Company is calculating it ratios relating to debt-paying ability for the year ended December 31,
20CY. Below is the relevant information:
Sales revenue
P325,000
Cost of goods sold and operating expenses
75,000
Interest expense
Income tax expense
Profit
9,000
20,000
6,000
12-31-CY
01-01-CY
Cash P 10,000
P 16,000
Accounts receivable
25,000
15,000
Inventory
45,000
60,000
Accounts payable
24,000
28,000
Taxes payable 11,000
13,000
The company uses 365 days in a year.
What is Mojo’s current ratio at December 31, 20CY?
2.220 to 1 2.286 to 1 3.250 to 1 3.420 to 1
Ans.
2.286 to 1
The purchase of raw materials for $85,000 on open account would
Increase the current ratio.
Decrease the current ratio.
Increase net working capital.
Decrease net working capital.
Ans.
Decrease the current ratio.
Selected data from Sheridan Corporation's year-end financial statements are presented below. The
difference between average and ending inventory is immaterial.
Current ratio 2.0
Quick ratio
1.5
Current liabilities
$120,000
Inventory turnover (based on cost of goods sold)
Gross profit margin
40%
Sheridan's net sales for the year were
$800,000.
$480,000.
$1,200,000.
$240,000.
Ans.
8 times
$800,000.
Star Manufacturing wants its treasurer to focus on improving the company‘s liquidity position. The
performance evaluation measures that are most likely relate to this behavior are?
Accounts receivable turnover, return on assets, and the current ratio.
Times interest earned in days, return on assets, and inventory turnover.
Inventory turnover in days, the current ratio, and returned on equity.
Accounts receivable turnover, inventory turnover in days, and the current ratio.
Ans.
Accounts receivable turnover, inventory turnover in days, and the current ratio.
The following computations were made from Bird Company’s 20CY books
Number of days sales in inventory
61
Number of days sales in trade accounts receivable 33
What was the number of days in Bird’s 20CY operating cycle?
33 94 61 47
Ans.
94
It is the policy of E-Prompt Corporation that the current ratio cannot fall below 1.5 to 1.0. Its current
liabilities are P400,000 and the present current ratio is 2 to 1. How much is the maximum level of new
short-term loans it can secure without violating the policy?
P400,000 P300,000 P266,667 P800,000
Ans.
P400,000
A corporation manages inventory performance by monitoring its inventory turnover. Selected financial
records for the corporation are as follows:
Annual gross sales
Annual profit percentage
Year 1
P2,262,500
45%
Year 2
P1,062,500
30%
Year 3
P1,459,000
40%
The beginning finished goods inventory for year 2 was 20% of year 2 sales. The ending finished goods
inventory for year 2 was 18% of year 3 sales. What was the corporation’s inventory turnover for year 2?
1.34 2.83 3.03 3.13
Ans.
3.13
Which of the following ratios should be used in evaluating the effectiveness with which the company
uses its assets?
1) Receivable Turnover Ratio
2) Dividend Payout Ratio
1) No
Ans.
1) Yes
2) No 1) Yes
2) No 1) Yes
2) Yes 1) No
2) Yes
2) No
Norton, Inc. has a 2 to 1 current ratio. This ratio would increase to more than 2 to 1 if
A previously declared stock dividend were distributed.
The company wrote off an uncollectible receivable.
The company sold merchandise on open account that earned a normal gross margin.
The company purchased inventory on open account.
Ans.
The company sold merchandise on open account that earned a normal gross margin.
Information from Davao Corporation’s balance sheet is as follows:
Current assets:
Cash
P 2,400,000
Marketable securities 7,500,000
Accounts receivable
57,600,000
Inventories
66,300 000
Prepaid expenses
1,200,000
Total current assets
P135,000,000
Current liabilities:
Notes payable P 1,500,000
Accounts payable
19,500,000
Accrued expenses
12,500,000
Income taxes payable 500,000
Payments due within one year on long-term debt
Total current liabilities P 37,500,000
3,500,000
What is the quick (acid) test ratio?
1.80 to 1 1.99 to 1 3.60 to 1
Ans.
1.80 to 1
Mojo Jojo Company is calculating it ratios relating to debt-paying ability for the year ended December 31,
20CY. Below is the relevant information:
Sales revenue
P325,000
Cost of goods sold and operating expenses
75,000
Interest expense
20,000
Income tax expense
6,000
Profit
9,000
12-31-CY
01-01-CY
Cash P 10,000
P 16,000
Accounts receivable
25,000
15,000
Inventory
45,000
60,000
Accounts payable
24,000
28,000
Taxes payable
11,000
13,000
The company uses 365 days in a year.
What is Mojo’s inventory turnover in 20CY?
1.143 times 1.250 times. 1.429 times
Ans.
1.429 times
How is the average inventory used in the calculation of each of the following?
1) Acid test (quick ratio)
2) Inventory turnover rate
1) Numerator
2) Numerator
1) Numerator
2) Denominator
1) Not Used
2) Denominator
1) Not Used
2) Numerator
Ans.
1) Not Used
2) Denominator
OTW Corporation has current assets totaling P15 million and a current ratio of 2.5 to 1. What is OTW’s
current ratio immediately after it had paid P2 millions of its accounts payable?
3.75 to 1
2.75 to 1 3.25 to 1 4.75 to 1
Ans.
3.25 to 1
Mendez Corporation discloses the following in relation to its financial statements for 20CY:
Cash P 37,500
Plant and equipment
441,000
Total assets
648,000
Income tax payable
37,500
Ordinary shares 450,000
Gross margin for 20CY 450,000
Accounts receivable, inventory, accounts payable,
long-term debt, and retained earnings ?
Total liabilities divided by total shareholders’ equity
0.8
Inventory turnover based on sales and ending inventory. 15 times
Inventory turnover based on cost of goods sold and
ending inventory
10.5 times
Current ratio, at year-end
1.5 to 1
The balance of long-term debt is?
P100,000 P 92,000 P150,000 P130,000
Ans.
P150,000
If the average age of the inventory is 90 days, the average age of accounts payable is 60 days, and the
average age of accounts receivables is 65 days, the number of days in the cash flow cycle is?
95 days 125 days 215 days 85 days
Ans.
95 days
Jack & Sons, Inc. has a 2 to 1 acid test (quick) ratio. This ratio would decrease to less than 2 to 1 if?
The company purchased inventory on open account.
he company sold merchandise on open account that earned a normal gross margin.
The company collected an account receivable.
The company paid an account payable.
Ans.
The company purchased inventory on open account.
Selected data taken from the financial statements of Johnny Company for the year indicated:
20PY 20CY 20NY
Accounts receivable, net
Inventory
40,000 50,000
Current assets 120,000
Total assets, net700,000
Current liabilities
70,000
Cash sales
400,000
Credit sales
120,000
Costs of sales 310,000
P40,000
45,000
140,000
750,000
80,000 50,000
420,000
125,000
324,000
P42,500
130,000
725,000
450,000
131,250
345,000
(Use 360 days in a year)
What should be the age of receivables for 20NY?
P45,000
110 days 120 days 130 days. 140 days
Ans.
120 days
The days' sales-in-receivables ratio will be understated if the company
Uses a natural business year for its accounting period.
Uses a calendar year for its accounting period.
Uses average receivables in the ratio calculation.
Does not use average receivables in the ratio calculation.
Ans.
Uses a natural business year for its accounting period.
Selected information for Cory Company for the year ended December 31, 20CY follows:
Average day’s sales in inventories
124
Average day’s sales in accounts receivables
48
The average number of days in the operating cycle for 20CY was?
172 124 86 76
Ans.
172
Minix Company has a high sales-to-working-capital ratio. This could indicate?
The firm is undercapitalized.
The firm is likely to have liquidity problems
Working capital is not profitably utilized.
The firm is not profitable.
Ans.
The firm is undercapitalized.
Markham's working capital would be
Decreased by the dividend declaration and increased by the dividend payment.
Unchanged by either the dividend declaration or the dividend payment.
Decreased by the dividend declaration and unchanged by the dividend payment.
Increased by the dividend declaration and unchanged by the dividend payment.
Ans.
Decreased by the dividend declaration and unchanged by the dividend payment.
Carson Corporation computed the following items from its financial records for the current year:
Current ratio 2 to 1
Inventory turnover
54 days
Accounts receivable turnover 24 days
Current liabilities turnover
36 days
The number of days in Carson's operating cycle for the current year was?
60. 90. 78. 42.
Ans.
78.
Alpha Company’s net accounts receivable were P500,000 at December 31, 20PY and P600,000 at
December 31, 20CY. Net cash sales for P20CY were P200,000. The accounts receivable turnover for
20CY was 5.0. What were Alpha’s net sales for 20CY?
P2,950,000 P3,000,000 P3,200,000 P5,500,000
Ans.
P2,950,000
Rice, Inc. uses the allowance method to account for uncollectible accounts. An account receivable that
was previously determined uncollectible and written off was collected during May. The effect of the
collection on Rice's current ratio and total working capital is receivable on Merit's current ratio and total
working capital would be
1)
Current Ratio
2)
Working Capital
1) None
2)
1) Increase
1) Increase
1) None
2)
Ans.
1) None
2)
None
2) Increase
2) None
Decrease
None
Selected data taken from the financial statements of Johnny Company for the year indicated:
20PY 20CY 20NY
Accounts receivable, net
Inventory
40,000 50,000
Current assets 120,000
Total assets, net700,000
P40,000
45,000
140,000
750,000
P42,500
130,000
725,000
P45,000
Current liabilities
70,000
Cash sales
400,000
Credit sales
120,000
Costs of sales 310,000
80,000 50,000
420,000
450,000
125,000
131,250
324,000
345,000
(Use 360 days in a year)
What is the estimated number of days in inventory for 20NY?
50 days. 60 days. 70 days 80 days.
Ans.
50 days.
A company has cash of P100 million, accounts receivable of P600 million, current assets of P1.2 billion,
accounts payable of P400 million, and current liabilities of P900 million. What is its acid-test (quick)
ratio?
0.11 0.78 1.75 2.11
Ans.
0.78
Mojo Jojo Company is calculating it ratios relating to debt-paying ability for the year ended December 31,
20CY8. Below is the relevant information:
Sales revenue
P325,000
Cost of goods sold and operating expenses
Interest expense
20,000
Income tax expense
6,000
Profit
9,000
75,000
12-31-CY
01-01-CY
Cash P 10,000
P 16,000
Accounts receivable
25,000
15,000
Inventory
45,000
60,000
Accounts payable
24,000
28,000
Taxes payable 11,000
13,000
The company uses 365 days in a year.
What is Mojo’s average collection period for accounts receivable in 20CY?
0.672 to 1 0.756 to 1 3.000 to 1 1.767 to 1
Ans.
0.756 to 1
Assume net credit sales and cost of goods sold for Year 2 were $300,000 and $220,000, respectively. The
accounts receivable and inventory balances are as follows
Beginning
Ending
Accounts receivable
P45,000
Inventory
60,000 50,000
P30,000
Lisa, Inc.'s accounts receivable turnover for Year 2 was?
4.9 times. 5.9 times. 6.7 times. 8.0 times.
Ans.
8.0 times.
For the year ending 31 August in 20CY, Sinatra Inc. reported the following statistics:
In thousand Pesos
August 31
20CY 20PY
Net credit sales 2,482
Gross receivables
140 128
Inventory
384 312
Cost of goods sold
1,752
For the current year, using a 365-day year, the average number of days to convert inventory to sales is?
65.00 days 51.18 days 72.56 days 71.51 days
Ans.
72.56 days
The ratio that measures a firm's ability to generate earnings from its resources is
Days' sales in inventory.
Sales to working capital.
Days' sales in receivables.
Asset turnover.
Ans.
Asset turnover.
To determine the operating cycle for a retail department store, which one of the following pairs of items
is needed?
Days' sales in accounts receivable and average merchandise inventory.
Cash turnover and net sales.
Accounts receivable turnover and inventory turnover.
Asset turnover and return on sales.
Ans.
Accounts receivable turnover and inventory turnover.
The following transactions occurred during a company's first year of operations:
I. Purchased a delivery van for cash
II. Borrowed money by issuance of short-term debt
III. Purchased treasury stock
Which of the items above caused a change in the amount of working capital?
I only. I and II only. II and III only. I and III only.
Ans.
I and III only.
Markham's current ratio would be
Decreased by the dividend declaration and increased by the dividend payment.
Increased by the dividend declaration and unchanged by the dividend payment.
Unchanged by either the dividend declaration or the dividend payment.
Unchanged by the dividend declaration and decreased by the dividend payment.
Ans.
Decreased by the dividend declaration and increased by the dividend payment.
Panga Company asked you to interpret the following ratios provided by its accountant on December 31,
20CY:
Acid-test ratio 1.2
Times interest earned 8
Gross margin ratio
40%
Inventory turnover
6
Debt-to-equity ratio
0.9 to 1
Ratio of operating expenses to sales
15%
Total shareholders’ equity on December 31, 20CY was P900,000. Gross margin for 20CY amounted to
P600,000. Beginning balance of merchandise inventory was P200,000. The company’s long-term
liabilities consisted of bonds payable with interest at 15%. You decided to reconstruct the company’s
financial statements based on the limited information given to serve as a basis for further analysis.
The company’s current assets amount to ?
P317,000 P597,000 P697,000 P622,000
Ans.
P622,000
What will happen to the ratios below if Tosh Enterprises uses cash to pay 25% of the accounts payable?
1) Current Ratio
2) Quick Ratio
1) Increase
1) Decrease
1) Increase
1) Decrease
Ans.
1) Increase
2)
2)
2)
2)
Increase
Decrease
Decrease
Increase
2) Increase
Payment of a trade account payable of $64,500 would
Increase the current ratio, but the quick ratio would not be affected.
Increase the quick ratio, but the current ratio would not be affected.
Increase both the current and quick ratios.
Decrease both the current and quick ratios.
Ans.
Increase both the current and quick ratios.
A corporation has P5,000,000 in 10 percent bonds and P3,000,000 in 12 percent preferred stock
outstanding. The firm's financial breakeven (assuming a 40 percent tax rate) is
P 860,000. P 716,000. P1,100,000. P1,400,000
Ans.
P1,100,000.
X Co. currently sells 400,000 bottles of perfume each year. Each bottle costs P.84 to produce & sells for
P1.00. Fixed costs are P28,000 per year. The firm has annual interest expense of P6,000, preferred stock
dividends of P2,000 per year, & a 40% tax rate.
The degree of financial leverage for X Co. is
2.4 1.78 1.35 1.2
Ans.
1.35
When calculating the cost of capital, the cost assigned to retained earnings should be
Zero
Lower than the cost of external common equity
Equal to the cost of external common equity
Higher than the cost of external common equity
Ans.
Lower than the cost of external common equity
The minimum return that a project must earn for a company in order to leave the value of the company.
unchanged is the
Current borrowing rate Discount rate Capitalization rate Cost of capital
Ans.
Cost of capital
The difference between the required rate of return on a given risky investment and that on a riskless
investment with the same expected return is the
Risk premium Coefficient of variation Standard deviation Beta coefficient
Ans.
Risk premium
If K is the cost of debt and t is the marginal tax rate, the after-tax cost of debt, ki, is best represented by
the formula
ki = k/t. ki = k/(1-t) ki = k(t). ki = k(1-t)
Ans.
ki = k(1-t)
The minimum return that a project must earn for a company in order to leave the value of the company.
unchanged is the
Current borrowing rate Discount rate Capitalization rate Cost of capital
Ans.
Cost of capital
D, Inc., which is interested in measuring its overall cost of capital, has gathered the following data.
Under the terms described below, the company can sell unlimited amounts of all instruments.
·D can raise cash by selling P1, 000, 8%, 20-year bonds with annual interest payments. In selling the
issue, an average premium of P30 per bond would be received, and the firm must pay flotation costs of
P30 per bond.
·D can sell 8% preferred stock at P105 per share. The cost of issuing and selling the preferred stock is
expected to be P5 per share.
·D’s common stock is currently selling for P100 per share. The firm expects to pay cash dividends of P7
per share next year, and the dividends are expected to remain constant. The stock will have to be
underpriced by P3 per share, and flotation costs are expected to amount to P5 per share.
·D’s expects to have available P100,000 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.
·D’s preferred capital structure is
Long-term debt 30%
Preferred stock 20
Common stock 50
· The applicable tax rate is 40%.
The cost of funds from the sale of commons stock for Z, Inc. is
7.0% 7.6% 7.4% 8.1%
Ans.
7.6%
Which of these statements are pertinent to cost of capital?
1. It is the return that investors demand for a given level of risk.
2. It may be employed as a benchmark for the evaluation of performance.
3. For investment decisions, it must be based on the current or prospective cost of the various capital
components rather than on their
historical costs.
4. It may also be used in acquisition analysis, liquidation studies and source of financing decisions.
5. It may differ from the hurdle rate used to reflect the alternative risk attributed to a specific project,
decision, or business unit.
All five statements.
Statements 1,2 and 3 only
Statements 1,2,3 and 4 only
Statements 1,2,4 and 5 only
Ans.
All five statements.
Which of the following are practical difficulties associated with capital structure and degree of leverage
analyses?
It is nearly impossible to determine exactly how P/E ratios or equity capitalization rates (ks values) are
affected by different degrees of financial leverage.
Managers’ attitudes toward risk differ and some managers may set a target capital structure other than
the one that would maximize stock price.
Managers often have a responsibility to provide continuous service; they must preserve the long-run
viability of the enterprise. Thus, the goal of employing leverage to maximize short-run stock price and
minimize capital cost may conflict with long-run viability.
All of the statements above are correct.
Ans.
All of the statements above are correct.
X Co. currently sells 400,000 bottles of perfume each year. Each bottle costs P.84 to produce & sells for
P1.00. Fixed costs are P28,000 per year. The firm has annual interest expense of P6,000, preferred stock
dividends of P2,000 per year, & a 40% tax rate.
The degree of operating leverage for X Co. is
2.4 1.78 2.13 1.2
Ans.
1.78
Which of the following criteria theoretically should be used to determine the valuation of common
stock?
Book value. Dividends. Beta coefficient. Standard deviation of returns.
Ans.
Dividends.
Which of the following statements is correct?
The WACC should include only after-tax component costs. Therefore, the required rates of return (or
“market rates”) on debt, preferred, and common equity (kd, kp, and ks) must be adjusted to an after-tax
basis before they are used in the WACC equation.
The cost of retained earnings is generally higher than the cost of new common stock. Preferred stock is
riskier to investors than is debt. Therefore, if someone told you that the market rates showed kd > kp for
a given company, that person must have made a mistake.
If a company with a debt ratio of 50 percent were suddenly exempted from all future income taxes,
then, all other things held constant, this would cause its WACC to increase.
Ans.
If a company with a debt ratio of 50 percent were suddenly exempted from all future income taxes, then,
all other things held constant, this would cause its WACC to increase.
In general, it is more expensive for a company to finance with equity capital than with debt capital
because.
Long-term bonds have a maturity date and must therefore be repaid in the future.
Investors are exposed to greater risk with equity capital.
Equity capital is in greater demand than debt capital.
Dividends fluctuate to a greater extent than interest rates.
Ans.
Investors are exposed to greater risk with equity capital.
All of the following are examples of imputed costs except
The stated interest paid on a bank loan
The use of the firm’s internal cash funds to purchase assets.
Assets that are considered obsolete that maintain a net book value.
Decelerated depreciation.
Ans.
The stated interest paid on a bank loan
The explicit cost of debt financing is the interest expense. The implicit cost (s) of debt financing is (are)
the
Increase in the cost of debt as the debt-to-equity ratio increases
Increase in the cost of debt and equity as the debt-to-equity ratio increases
Increase in the cost of equity as the debt-to-equity ratio decreases
Decrease in the weighted-average cost of capital as the debt-to-equity ratio increase
Ans.
Increase in the cost of debt and equity as the debt-to-equity ratio increases
MF Company has made the decision to finance next year’s capital projects through debt rather than
additional equity. The benchmark cost of capital for these projects should be
The before-tax cost of new-debt financing
The after-tax cost of new-debt financing.
The cost of equity financing.
The weighted-average cost of capital.
Ans.
The weighted-average cost of capital.
Newmass, Inc. paid cash dividends to its ordinary shareholders over the past 12 months at P2.20 per
share. The current market value of the common stocks is P40 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. The cost of a new common stock issue will be.
11.50% 11.79% 11.83% 12.14%
Ans.
12.14%
Yolanda, Inc. is planning to use retained earnings to finance anticipated capital expenditures. The beta
coefficient for Yolanda’s stock is 1.15, the market rate is 12.5% and the risk-free rate is 8.50%. If a new
issue of common stock were used in this model, the flotation costs would be 7%. By using the capital
asset pricing model (CAPM) equation [R = RF + ß (RM –RF)], the cost of using retained earnings to
finance the capital expenditures is 12.50% 14.38% 13.78% 13.10%
Ans.
13.10%
A firm’s optimal capital structure
Minimizes the firm’s tax liability.
Minimizes the firm’s risk.
Maximizes the firm’s degree of financial leverage.
Maximizes the price of the firm’s stock.
Ans.
Maximizes the price of the firm’s stock.
The minimum return that a project must earn for a company in order to leave the value of the company
unchanged is the
Current borrowing rate Discount rate Capitalization rate Cost of capital
Ans.
Cost of capital
The three elements needed to estimate the cost of equity capital for use in determining a firm’s
weighted-average cost of capital are
Current dividends per share, expected growth rate in dividends per share, and current book value per
share of common stock.
Current earnings per share, expected growth rate in dividends per share, and current market price per
share of common stock.
Current earnings per share, expected growth rate in earnings per share, and current book value per
share of common stock.
Current dividends per share, expected growth rate in dividends per share, the current market price per
share of common stock.
Ans.
Current dividends per share, expected growth rate in dividends per share, the current market price per
share of common stock.
The capital asset pricing model assumes
all investors are price takers.
all investors have the same holding period.
investors pay taxes on capital gains.
both a and b are true.
Ans.
both a and b are true.
A company had P500,000 of sales for the year just ended and is projecting sales of P600,000 for the
coming year. For every P1 increase in sales, 38 cents 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. The amount of additional external financing needed by the company in
the coming year is
P 0 P38,000 P 86,000 P110,000
Ans.
P0
A firm must select from among several methods of financing arrangements when meeting its capital
requirements. To acquire additional growth capital while attempting to maximize earnings per share, a
firm should normally
Attempt to increase both debt and equity in equal proportions, which preserves a stable capital
structure and maintains investor confidence.
Select debt over equity initially, even through increased debt is accompanied by interest costs and a
degree of risk.
Select equity over debt initially, which minimizes risk and avoids interest costs.
Discontinue dividends and use current cash flow, which avoids the cost and risk of increased debt and
the dilution of EPS through increased equity.
Ans.
Select debt over equity initially, even through increased debt is accompanied by interest costs and a
degree of risk.
R Company operates a chain of restaurants located in the metropolis. The company has steadily grown
to its present size of 48 restaurants. The board of directors recently approved a large-scale remodeling
of the restaurant, and the company is now considering two financing alternatives.
1.
The first alternative would consist of
Bonds that would have 9% coupon rate and would net P19.2 million after flotation costs.
Preferred stock with a stated rate of 6% that would yield P4.8 million after a 4% flotation cost.
Ordinary share that would yield P24 million after a 5% flotation cost.
2.
The second alternative would consist of a public offering of bonds that would have an 11%
coupon rate and would net P48 million after flotation costs.
R’s current capital structure, which is considered optimal, consists of 40% long-term debt, 10% preferred
stock, and 50% common stock. The current market value of the common stock is P30 per share, and the
common stock dividend during the past 12 months was P3 per share. Investors are expecting the growth
rate of dividends to equal the historical rate of 6%. R is subject to an effective income tax rate of 40%.
The after-tax cost of the common stock proposed in R’s first financing alternative would be.
16.05 16.53% 16.60% 17.16%
Ans.
17.16%
R Company operates a chain of restaurants located in the metropolis. The company has steadily grown
to its present size of 48 restaurants. The board of directors recently approved a large-scale remodeling
of the restaurant, and the company is now considering two financing alternatives.
1.
The first alternative would consist of
Bonds that would have 9% coupon rate and would net P19.2 million after flotation costs.
Preferred stock with a stated rate of 6% that would yield P4.8 million after a 4% flotation cost.
Ordinary share that would yield P24 million after a 5% flotation cost.
2.
The second alternative would consist of a public offering of bonds that would have an 11%
coupon rate and would net P48 million after flotation costs.
R’s current capital structure, which is considered optimal, consists of 40% long-term debt, 10% preferred
stock, and 50% common stock. The current market value of the common stock is P30 per share, and the
common stock dividend during the past 12 months was P3 per share. Investors are expecting the growth
rate of dividends to equal the historical rate of 6%. R is subject to an effective income tax rate of 40%.
Assuming the after-tax cost of common stock is 15%, the after-tax weighted marginal cost of capital for
R’s first financing alternative consisting of bonds, preferred, and common stock would be.
5.4% 6.25% 10.285% 11.700%
Ans.
10.285%
D Telecom is considering a project for the coming year that will cost P50 million. D plans to use the
following combination of debt and equity to finance the investment
·
Issue P15 millions of 20-year bonds at a price of 101, with a coupon rate of 8%, and flotation costs
of 2% of par.
·
Use of P35 millions of funds generated from earnings.
The equity market is expected to earn 12%. Philippine Treasury bills are currently yielding 5%. The beta
coefficient for D is estimated to be .60. D is subject to an effective corporate income tax rate of 40%.
Assume that the after-tax cost of debt is 7% and the cost of equity is 12%. Determine the weightedaverage cost of capital.
10.50% 8.50% 9.50% 6.30%
Ans.
10.50%
KG Inc. has the following mix of funds and costs:
Type Amount
Cost
Debt P 150,000
0.18%
Preference share
500,000
Ordinary equity 700,000
0.12
Total funds
P1,350,000
What is KG’s cost of capital?
13.78% 12.22% 15.22% 13.22%
Ans.
13.78%
0.15
R Company operates a chain of restaurants located in the metropolis. The company has steadily grown
to its present size of 48 restaurants. The board of directors recently approved a large-scale remodeling
of the restaurant, and the company is now considering two financing alternatives.
1.
The first alternative would consist of
Bonds that would have 9% coupon rate and would net P19.2 million after flotation costs.
Preferred stock with a stated rate of 6% that would yield P4.8 million after a 4% flotation cost.
Ordinary share that would yield P24 million after a 5% flotation cost.
2.
The second alternative would consist of a public offering of bonds that would have an 11%
coupon rate and would net P48 million after flotation costs.
R’s current capital structure, which is considered optimal, consists of 40% long-term debt, 10% preferred
stock, and 50% common stock. The current market value of the common stock is P30 per share, and the
common stock dividend during the past 12 months was P3 per share. Investors are expecting the growth
rate of dividends to equal the historical rate of 6%. R is subject to an effective income tax rate of 40%.
The after tax weighted marginal cost of capital for R’s second financing alternative consisting solely of
bonds would be.
5.13% 5.40% 6,27% 6.60%
Ans.
6.60%
Z Company, which is interested in measuring its overall cost of capital, has gathered the following data.
Under the terms described below, the company can sell unlimited amounts of all instruments.
· 1. Z can raise cash by selling P1, 000, 8%, 20-year bonds with annual interest payments. In selling the
issue, an average premium of P30 per bond would be received, and the firm must pay flotation costs of
P30 per bond. The after tax cost of funds is estimated to be 4.8%.
2.
Z can sell 8% preferred stock at P105 per share. The cost of issuing and selling the preferred stock
is expected to be P5 per share.
3.
Z’s common stock is currently selling for P100 per share. The firm expects to pay cash dividends of
P7 per share next year, and the dividends are expected to remain constant. The stock will be
underpriced by P3 per share, and flotation costs are expected to amount to P5 per share.
4.
Z expected to have available P100,000 of retained earnings in the coming year. Once these
retained earnings are exhausted, the firm uses ordinary share as the form of ordinary equity financing.
·
Z’s preferred capital structure is
Long-term debt
30%
Preferred stock
20
Common stock
50
5.
The applicable tax rate is 40%.
The cost of funds from the sale of ordinary share for Z Company is
7.0% 7.6% 7.4% 8.1%
Ans.
7.6%
It refers to the practice of financing assets with borrowed capital. Its extensive use may impact on the
return on common shareholders’ equity to be above or below the rate or return on total assets.
Discounting. Mortgage Leverage Arbitrage
Ans.
Leverage
R Company operates a chain of restaurants located in the metropolis. The company has steadily grown
to its present size of 48 restaurants. The board of directors recently approved a large-scale remodeling
of the restaurant, and the company is now considering two financing alternatives.
1.
The first alternative would consist of
Bonds that would have 9% coupon rate and would net P19.2 million after flotation costs.
Preferred stock with a stated rate of 6% that would yield P4.8 million after a 4% flotation cost.
Ordinary share that would yield P24 million after a 5% flotation cost.
2.
The second alternative would consist of a public offering of bonds that would have an 11%
coupon rate and would net P48 million after flotation costs.
R’s current capital structure, which is considered optimal, consists of 40% long-term debt, 10% preferred
stock, and 50% common stock. The current market value of the common stock is P30 per share, and the
common stock dividend during the past 12 months was P3 per share. Investors are expecting the growth
rate of dividends to equal the historical rate of 6%. R is subject to an effective income tax rate of 40%
The after-tax weighted average cost of capital under the first financing alternative is.
11.365% 17.16% 17.40% 11.34%
Ans.
11.365%
Assume that nominal interest has just increased substantially but that the expected future dividends for
a company over the long run were not affected. As a result of the increase in nominal interest rates, the
company’s stock price should.
Increase Decrease Stay constant Change, but in no obvious direction
Ans.
Decrease
Telecom is considering a project for the coming year that will cost P50 million. D plans to use the
following combination of debt and equity to finance the investment
·
Issue P15 millions of 20-year bonds at a price of 101, with a coupon rate of 8%, and flotation costs
of 2% of par.
·
Use of P35 millions of funds generated from earnings.
The equity market is expected to earn 12%. Philippine Treasury bills are currently yielding 5%. The beta
coefficient for D is estimated to be .60. D is subject to an effective corporate income tax rate of 40%.
The capital asset pricing model (CAPM) computes the expected return on a security by adding the riskfree rate of return to the incremental yield of the expected market return, which is adjusted by the
company’s beta. Compute D’s expected rate of return using the CAPM
9.20% 12.20% 7.20% 12.00%
Ans.
9.20%
Z Company, which is interested in measuring its overall cost of capital, has gathered the following data.
Under the terms described below, the company can sell unlimited amounts of all instruments.
·
Z can raise cash by selling P1, 000, 8%, 20-year bonds with annual interest payments. In selling the
issue, an average premium of P30 per bond would be received, and the firm must pay flotation costs of
P30 per bond. The after tax cost of funds is estimated to be 4.8%.
·
Z can sell 8% preferred stock at P105 per share. The cost of issuing and selling the preferred stock
is expected to be P5 per share.
·
Z’s common stock is currently selling for P100 per share. The firm expects to pay cash dividends of
P7 per share next year, and the dividends are expected to remain constant. The stock will be
underpriced by P3 per share, and flotation costs are expected to amount to P5 per share.
·
Z expected to have available P100,000 of retained earnings in the coming year. Once these
retained earnings are exhausted, the firm uses ordinary share as the form of ordinary equity financing.
·
Z’s preferred capital structure is
Long-term debt
30%
Preferred stock
20
Common stock
50
·
The applicable tax rate is 40%.
If Z needs a total of P200,000, the firm’s weighted average cost of capital would be.
19.8% 4.8% 6.5% 6.8%
Ans.
6.5%
D Telecom is considering a project for the coming year that will cost P50 million. D plans to use the
following combination of debt and equity to finance the investment
·
Issue P15 millions of 20-year bonds at a price of 101, with a coupon rate of 8%, and flotation costs
of 2% of par.
·
Use of P35 millions of funds generated from earnings.
The equity market is expected to earn 12%. Philippine Treasury bills are currently yielding 5%. The beta
coefficient for D is estimated to be .60. D is subject to an effective corporate income tax rate of 40%.
The before-tax cost of D’s planned debt financing, net of flotation costs, in the first year is.
11.60% 8.08% 10.00% 7.92%
Ans.
8.08%
Z Company, which is interested in measuring its overall cost of capital, has gathered the following data.
Under the terms described below, the company can sell unlimited amounts of all instruments.
·
Z can raise cash by selling P1, 000, 8%, 20-year bonds with annual interest payments. In selling the
issue, an average premium of P30 per bond would be received, and the firm must pay flotation costs of
P30 per bond. The after tax cost of funds is estimated to be 4.8%.
·
Z can sell 8% preferred stock at P105 per share. The cost of issuing and selling the preferred stock
is expected to be P5 per share.
·
Z’s common stock is currently selling for P100 per share. The firm expects to pay cash dividends of
P7 per share next year, and the dividends are expected to remain constant. The stock will be
underpriced by P3 per share, and flotation costs are expected to amount to P5 per share.
·
Z expected to have available P100,000 of retained earnings in the coming year. Once these
retained earnings are exhausted, the firm uses ordinary share as the form of ordinary equity financing.
·
Z’s preferred capital structure is
Long-term debt
30%
Preferred stock
20
Common stock
50
The applicable tax rate is 40%.
If Z needs a total of P1, 000, 000, the firm’s weighted average cost of capital would be.
6.8% 4.8% 6.5% 27.4%
Ans.
6.8%
Z Company, which is interested in measuring its overall cost of capital, has gathered the following data.
Under the terms described below, the company can sell unlimited amounts of all instruments.
·
Z can raise cash by selling P1, 000, 8%, 20-year bonds with annual interest payments. In selling the
issue, an average premium of P30 per bond would be received, and the firm must pay flotation costs of
P30 per bond. The after tax cost of funds is estimated to be 4.8%.
·
Z can sell 8% preferred stock at P105 per share. The cost of issuing and selling the preferred stock
is expected to be P5 per share.
·
Z’s common stock is currently selling for P100 per share. The firm expects to pay cash dividends of
P7 per share next year, and the dividends are expected to remain constant. The stock will be
underpriced by P3 per share, and flotation costs are expected to amount to P5 per share.
·
Z expected to have available P100,000 of retained earnings in the coming year. Once these
retained earnings are exhausted, the firm uses ordinary share as the form of ordinary equity financing.
·
Z’s preferred capital structure is
Long-term debt
30%
Preferred stock
20
Common stock
50
·
The applicable tax rate is 40%.
The cost of funds from retained earnings for Z Company is
7.0% 7.6% 7.4% 8.1%
Ans.
7.0%
Gary, Inc. is planning to use retained earnings to finance anticipated capital expenditures. The beta
coefficient for Gary’s stock is 1.15. The risk-free rate of interest is 8.5%, and the market return is
estimated at 12.4%. If a new issue of ordinary share were used in this model, the flotation costs would
be 7%. By using the capital asset pricing model (CAPM) equation [R = RF + ß (RM –RF)], the cost of using
retained earnings to finance the capital expenditures is.
13.21% 12.99% 12.40% 14.26%
Ans.
12.99%
The “inflation element” refers to the
Impact that future price increases will have on the original cost of capital expenditure.
Fact that the real purchasing power of a monetary unit usually increases over time.
Future deterioration of the general purchasing power of the monetary unit.
Future increases in the general purchasing power of the monetary unit.
Ans.
Future deterioration of the general purchasing power of the monetary unit.
Carmelo Company currently sells 400,000 bottles of perfume each year. Each bottle costs P.84 to
produce and sells for P1.00. Fixed costs are P28,000 per year. The firm has annual interest expense of
P6,000, preference share dividends of P2,000 per year, and a 40% tax rate.
If Carmelo Company did not have preferred stock, the degree of total leverage would.
Decrease in proportion to a decrease in financial leverage.
Increase in proportion to a decrease in financial leverage.
Remain the same.
Decrease but not be proportional to the decrease in financial leverage.
Ans.
Remain the same.
Which of the changes in leverage would apply to a company that substantially increases its investments
in fixed assets as a proportion of total assets and replaces some of its long-term debt with equity?
Financial
Operating
Leverage
Leverage
Increase
Decrease
Decrease
Increase
Increase
Increase
Decrease
Decrease
Ans.
Decrease
Increase
Carmelo Company currently sells 400,000 bottles of perfume each year. Each bottle costs P.84 to
produce and sells for P1.00. Fixed costs are P28,000 per year. The firm has annual interest expense of
P6,000, preference share dividends of P2,000 per year, and a 40% tax rate.
The degree of operating leverage for Carmelo Company is.
2.40 1.78 2.13 1.12
Ans.
1.78
X Co. currently sells 400,000 bottles of perfume each year. Each bottle costs P.84 to produce & sells for
P1.00. Fixed costs are P28,000 per year. The firm has annual interest expense of P6,000, preferred stock
dividends of P2,000 per year, & a 40% tax rate.
The degree of financial leverage for X Co. is
2.4 1.78 1.35 1.2
Ans.
1.35
If two companies, company X and Y, are alike in all respects except that company X employs more debt
financing and less equity financing than company Y does, which of the following statements is true?
Company X has more net earnings variability than company Y.
Company X has more operating earnings variability than company Y.
Company X has less operating earnings variability than company Y.
Company X has less financial leverage than company Y.
Ans.
Company X has more net earnings variability than company Y.
In its first year of operations, a firm had P50,000 of fixed operating costs. It sold 10,000 units at a P10
unit price and incurred variable costs of P4 per unit. If all prices and costs will be the same in the second
year and sales are projected to rise to 25,000 units, what will the degree of operating leverage (the
extent to which fixed costs are used in the firm’s operations) be in the second year?
1.25 1.50 2.0 6.0
Ans.
1.50
If a company has a higher dividend-payout ratio, then, if all else is equal, it will have.
A higher marginal cost of capital.
A lower marginal cost of capital.
A higher investment opportunity schedule.
A lower investment opportunity schedule.
Ans.
A higher marginal cost of capital.
A corporation has $5,000,000 in 10 percent bonds and $3,000,000 in 12 percent preferred stock
outstanding. The firm's financial breakeven (assuming a 40 percent tax rate) is
$ 860,000. $ 716,000. $1,100,000. $1,400,000
Ans.
$1,100,000.
The capital budget is a (n)
Plan to insure that there are sufficient funds available for the operating needs of the company.
Exercise that sets the long-range goals of the company including the consideration of external
influences.
Plan that coordinates and communicates a company’s plan for the coming year to all departments and
divisions.
Plan that assesses the long-term needs of the company for plant and equipment purchases.
Ans.
Plan that assesses the long-term needs of the company for plant and equipment purchases.
Capital budgeting techniques are least likely to be used in evaluating the
Acquisition of new aircraft by a cargo company.
Design and implementation of a major advertising program.
Adoption of a new method of allocating non-traceable cost to product lines.
Sale by a conglomerate of an unprofitable division.
Ans.
Adoption of a new method of allocating non-traceable cost to product lines.
The consulting firm of Magaling Corporation is considering the replacement of their computer system.
Taking into account the income tax effect and considering the carrying value of the old system (CVOS)
and the residual value of the new system (RVNS), which combination below applies to the decision
making process?
CVOS, irrelevant and RVNS, irrelevant.
CVOS, irrelevant and RVNS, relevant.
CVOS, relevant and RVNS, irrelevant.
CVOS, relevant and RVNS, relevant.
Ans.
CVOS, irrelevant and RVNS, relevant.
In equipment-replacement decisions, which one of the following does not affect the decision-making
process?
Current disposal price of the old equipment.
Operating costs of the old equipment.
Original fair market value of the old equipment.
Cost of the new equipment.
Ans.
Original fair market value of the old equipment.
Malen Movers, Inc. is planning to purchase equipment to make its operations more efficient. This
equipment has an estimated useful life of six years. As part of this acquisition, a P150,000 investment in
working capital is required. In a discounted cash flow analysis, this investment in working capital?
Should be amortized over the useful life of the equipment.
Should be disregarded because no cash is involved.
Should be treated as a recurring annual cash flow that is recovered at the end of six years.
Should be treated as an immediate cash outflow that is recovered at the end of six years.
Ans.
Should be treated as an immediate cash outflow that is recovered at the end of six years.
Of the following decisions, capital budgeting techniques would least likely be used in evaluating the
Acquisition of new aircraft by a cargo company.
Design and implementation of a major advertising program.
Trade for a star quarterback by a football team.
Adoption of a new method of allocating nontraceable costs to product lines.
Ans.
Adoption of a new method of allocating nontraceable costs to product lines.
In capital expenditures decisions, the following are relevant in estimating operating costs except:
Future costs Cash costs Differential costs Historical costs
Ans.
Historical costs
Capital budgeting is concerned with
Decisions affecting only capital intensive industries.
Analysis of short-range decisions.
Analysis of long-range decisions.
Scheduling office personnel in office buildings.
Ans.
Analysis of long-range decisions.
All of the following are methods that aid management in analyzing the expected result of capital
budgeting decisions, except:
Accrual accounting rate of return.
Payback method.
Future value cash flow.
Discounted cash flow rate of return.
Ans.
Future value cash flow.
In capital budgeting decisions, the following items are considered among others:
1.
Cash outflow for the investment.
2.
Increase in working capital requirement.
3.
Profit on sale of old asset.
4.
Loss on write-off of old asset.
For which of the above items would taxes be relevant?
Items 1 and 3 only. Items 3 and 4 only. All items Items 1 3 and 4 only
Ans.
Items 3 and 4 only.
High-Tech Industries is considering the acquisition of a new state-of-the-art manufacturing machine to
replace a less efficient machine. Hi-Tech has completed a net present value analysis and found it to be
favorable. Which one of the following factors should not be of concern to Hi-Tech in its acquisition
considerations?
The availability of any necessary financing.
The probability of near-term technological changes to the manufacturing process.
The investment tax credit.
Maintenance requirements, warranties, and availability of service arrangements.
Ans.
The investment tax credit.
Capital budgeting is used for the decision analysis of
Adding product lines or facilities.
Multiple profitable alternatives.
Lease-or-buy decisions.
All of the answers are correct.
Ans.
All of the answers are correct.
As a capital budgeting technique, the payback period considers depreciation expense (DE) and time
value of money (TVM) as follows:
DE, relevant and TVM, relevant.
DE, irrelevant and TVM, irrelevant.
DE, irrelevant and TVM, relevant.
DE, relevant and TVM, irrelevant.
Ans.
DE, irrelevant and TVM, irrelevant.
Lawson Inc. is expanding its manufacturing plant, which requires an investment of P4 million in new
equipment and plant modifications. Lawson’s sales are expected to increase by P3 million per year as are
a result of the expansion. Cash investments in current assets average 30% of sales; accounts payable and
other current liabilities are 10% of sales. What is the estimated total investment for this expansion?
P3.4 million. P4.3 million. P4.6 million. P5.2 million.
Ans.
P4.6 million.
Lawson Inc. is expanding its manufacturing plant, which requires an investment of $4 million in new
equipment and plant modifications. Lawson's sales are expected to increase by $3 million per year as a
result of the expansion. Cash investment in current assets averages 30% of sales; accounts payable and
other current liabilities are 10% of sales. What is the estimated total investment for this expansion?
$3.4 million $4.3 million. $4.6 million $4.9 million
Ans.
$4.6 million
Key Corp. plans to replace a production machine that was acquired several years ago. Acquisition cost is
P450,000 with residual value of P50,000. The machine being considered is worth P800,000 and the
supplier is willing to accept the old machine at a trade-in value of P60,000. Should the company decide
not to acquire the new machine, it needs to repair the old one at a cost of P200,000. Tax wise, the tradein transaction will not have any implication but the cost to repair is tax-deductible. The effective
corporate tax rate is 35% of profit subject to tax. For purposes of capital budgeting, the net investment in
the new machine is
P540,000 P610,000 P660,000 P800,000
Ans.
P610,000
Karen Company is considering replacing an old machine with a new machine. Which of the following
items is economically relevant to Karen’s decisions? Ignore income tax consideration.
Carrying amount of old machine – Yes
Disposal value of new machine – Yes
Carrying amount of old machine – Yes
Disposal value of old machine – No
Carrying amount of old machine – No
Disposal value of old machine – Yes
Carrying amount of old machine- No
Disposal value of old machine – No
Ans.
Carrying amount of old machine – No
Disposal value of old machine – Yes
High-Tech Industries is considering the acquisition of a new state-of-the-art manufacturing machine to
replace a less efficient machine. Hi-Tech has completed a net present value analysis and found it to be
favorable. Which one of the following factors should not be of concern to Hi-Tech in its acquisition
considerations?
The availability of any necessary financing.
The probability of near-term technological changes to the manufacturing process.
The investment tax credit.
Maintenance requirements, warranties, and availability of service arrangements.
Ans.
The investment tax credit.
Diliman Republic Publishers, Inc. is considering replacing an old press that cost P800,000 six years ago
with a new one that would cost P2,250,000. Shipping and installation would cost an additional P200,000.
The old press has a residual value of P150,000 and could be sold currently for P50,000. The increased
production of the new press would increase inventories by P40,000, accounts receivable by P160,000
and accounts payable by P140,000. Diliman Republic’s net initial investment for analyzing the acquisition
of the new press assuming a 35% income tax rate would be?
P2,450,000 P2,425,000 P2,600,000 P2,250,000
Ans.
P2,425,000
Regal Industries is replacing a grinder purchased 5 years ago for $15,000 with a new one costing $25,000
cash.The original grinder is being depreciated on a straight-line basis over 15 years to a zero salvage
value; Regal will sell this old equipment to a third party for $6,000 cash. The new equipment will be
depreciated on a straight-line basis over 10 years to a zero salvage value. Assuming a 40% marginal tax
rate, Regal's net cash investment at the time of purchase if the old grinder is sold and the new one
purchased is?
$19,000 $15,000 $17,400 $25,000
Ans.
$17,400
Regal Industries is replacing a grinder purchased 5 years ago for P15,000 with a new one costing
P25,000 cash. The original grinder is being depreciated on a straight-line basis over 15 years to a zero
residual value. Regal will sell this old equipment to a third party for P6,000 cash. The new equipment
will be depreciated on a straight-line basis over 10 years to a zero residual value. Assuming a 40%
marginal tax rate, Regal’s net cash investment at the time of purchase if the old grinder is sold and the
new one purchased is
P19,000 P15,000 P17,400 P25,000
Ans.
P17,400
In order to increase production capacity, Gunning Industries is considering replacing an existing
production machine with a new technologically improved machine effective January 1. The following
information is being considered by Gunning Industries:
ｷ The new machine would be purchased for $160,000 in cash. Shipping, installation, and testing would
cost an additional $30,000.
ｷ The new machine is expected to increase annual sales by 20,000 units at a sales price of $40 per unit.
Incremental operating costs include $30 per unit in variable costs and total fixed costs of $40,000 per
year.
ｷ The investment in the new machine will require an immediate increase in working capital of $35,000.
This cash outflow will be recovered at the end of year 5.ｷ Gunning uses straight-line depreciation for
financial reporting and tax reporting purposes. The new machine has an estimated useful life of 5 years
and zero salvage value.ｷ Gunning is subject to a 40% corporate income tax rate.
Gunning uses the net present value method to analyze investments and will employ the following factors
and rates:
Period
1
2
3
4
5
Present Value Present Value of an Ordinary
of $1 at 10% Annuity of $1 at 10%
.909
.909
.826
1.736
.751
2.487
.683
3.170
.621
3.791
Gunning Industries' net cash outflow in a capital budgeting decision is
$190,000 $195,000 $204,525 $225,000
Ans.
$225,000
Kline Corporation is expanding its plant, which requires an investment of $8 million in new equipment.
Kline's sales are expected to increase by $6 million per year as a result of the expansion. Cash investment
in current assets averages 30% of sales, and accounts payable and other current liabilities are 10% of
sales. What is the estimated total cash investment for this expansion?
$6.8 million $8.6 million $9.2 million $9.8 million
Ans.
$9.2 million
The Moore Corporation is considering the acquisition of a new machine. The machine can be purchased
for $90,000; it will cost $6,000 to transport to Moore's plant and $9,000 to install. It is estimated that the
machine will last 10 years, and it is expected to have an estimated salvage value of $5,000. Over its 10year life, the machine is expected to produce 2,000 units per year with a selling price of $500 and
combined material and labor costs of $450 per unit. Federal tax regulations permit machines of this type
to be depreciated using the straight-line method over 5 years with no estimated salvage value. Moore
has a marginal tax rate of 40%.
What is the net cash flow for the third year that Moore Corporation should use in a capital budgeting
analysis?
$68,400 $68,000 $64,200 $79,000
Ans.
$68,400
On January 1, Crane Company will acquire a new asset that costs $400,000 and is anticipated to have a
salvage value of $30,000 at the end of 4 years. The new asset ｷ Qualifies as 3-year property under the
Modified Accelerated Cost Recovery System (MACRS).ｷ Will replace an old asset that currently has a tax
basis of $80,000and can be sold now for $60,000.ｷ Will continue to generate the same operating
revenues as the old asset ($200,000 per year). However, savings in operating costs will be experienced
as follows: a total of $120,000 in each of the first 3 years and $90,000 in the fourth year. Crane is subject
to a 40% tax rate and rounds all computations to the nearest dollar. Assume that any gain or loss affects
the taxes paid at the end of the year in which it occurred. The company uses the net present value
method to analyze projects using the following factors and rates:
Present Value Present Value of
Period of $1 at 14% $1 Annuity at 14% MACRS
1
.88
.88
33%
2
.77
1.65
45
3
.68
2.33
15
4
.59
2.92
7
The present value of the depreciation tax shield for the fourth year MACRS depreciation of Crane
Company's new asset is?
$0 $6,112 $6,608 $16,520
Ans.
$6,608
Which of the following statements concerning cash flow determination for capital budgeting purposes is
not correct?
Tax depreciation must be considered because it affects cash payment for taxes.
Book depreciation is relevant because it affects profit.
Net working capital changes should be included in cash flow forecasts.
Relevant opportunity costs should be included in cash flow forecasts.
Ans.
Book depreciation is relevant because it affects profit.
Waltz Co. is considering the acquisition of a new, more efficient press. The cost of the press is P360,000,
and the press has an estimated 6-year life with zero residual value. Waltz uses straight-line depreciation
for both financial reporting and income tax reporting purposes and has a 40% corporate income tax rate.
In evaluating equipment acquisitions of this type, Waltz uses a goal of a 4-year payback period. To meet
Waltz desired payback period, the press must produce a minimum annual before-tax operating cash
savings of
P90,000 P110,000 P114,000 P150,000
Ans.
P110,000
The Dickins Corporation is considering the acquisition of a new machine at a cost of $180,000.
Transporting the machine to Dickins' plant will cost $12,000. Installing the machine will cost an
additional $18,000. It has a 10-year life and is expected to have a salvage value of $10,000. Furthermore,
the machine is expected to produce 4,000 units per year with a selling price of $500 and combined direct
materials and direct labor costs of $450 per unit. Federal tax regulations permit machines of this type to
be depreciated using the straight-line method over 5 years with no estimated salvage value. Dickins has a
marginal tax rate of 40%.
What is the net cash flow for the tenth year of the project that Dickins should use in a capital budgeting
analysis?
$200,000 $158,000 $136,800 $126,000
Ans.
$126,000
Depreciation is incorporated explicitly in the discounted cash flow analysis of an investment proposal
because it
Is a cost of operations that cannot be avoided.
Is a cash inflow.
Reduces the cash outlay for income taxes.
Represents the initial cash outflow spread over the life of the investment.
Ans.
Reduces the cash outlay for income taxes.
A depreciation tax shield is?
An after-tax cash outflow.
A reduction in income taxes.
The cash provided by recording depreciation.
The expense caused by depreciation.
Ans.
A reduction in income taxes.
Arlene Inc. currently has annual cash revenues of P2,400,000 and annual operating costs of P1,850,000
(all cash items except depreciation of P350,000). The company is considering the purchase of a new
machine costing P1,200,000 that would increase cash revenues to P2,900,000 and operating costs
(including depreciation) to P2,050,000. The new machine would increase depreciation to P500,000 per
year. Revenues are expected to increase to 2,900,000 and assuming a 35% income tax rate, Arlene’s
incremental after tax cash flows from the machine would be:
P330,000 P345,000 P295,000 P300,000
Ans.
P345,000
The annual tax depreciation expense on an asset reduces income taxes by an amount equal to
The firm's average tax rate times the depreciation amount.
One minus the firm's average tax rate times the depreciation amount.
The firm's marginal tax rate times the depreciation amount.
One minus the firm's marginal tax rate times the depreciation amount.
Ans.
The firm's marginal tax rate times the depreciation amount.
In order to increase production capacity, Gunning Industries is considering replacing an existing
production machine with a new technologically improved machine effective January 1. The following
information is being considered by Gunning Industries:
ｷ The new machine would be purchased for $160,000 in cash. Shipping, installation, and testing would
cost an additional $30,000.
ｷ The new machine is expected to increase annual sales by 20,000 units at a sales price of $40 per unit.
Incremental operating costs include $30 per unit in variable costs and total fixed costs of $40,000 per
year.
ｷ The investment in the new machine will require an immediate increase in working capital of $35,000.
This cash outflow will be recovered at the end of year 5.ｷ Gunning uses straight-line depreciation for
financial reporting and tax reporting purposes. The new machine has an estimated useful life of 5 years
and zero salvage value.ｷ Gunning is subject to a 40% corporate income tax rate.
Gunning uses the net present value method to analyze investments and will employ the following factors
and rates:
Present Value Present Value of an Ordinary
Period of $1 at 10% Annuity of $1 at 10%
1
.909
.909
2
.826
1.736
3
.751
2.487
4
.683
3.170
5
.621
3.791
Gunning Industries' discounted annual depreciation tax shield for the year of replacement is
$13,817 $16,762 $20,725 $22,800
Ans.
$13,817
Fast Freight, Inc. is planning to purchase equipment to make its operations more efficient. This
equipment has an estimated life of 6 years. As part of this acquisition, a $75,000 investment in working
capital is anticipated. In a discounted cash flow analysis, the investment in working capital.
Should be amortized over the useful life of the equipment.
Can be disregarded because no cash is involved.
Should be treated as an immediate cash outflow.
Should be treated as an immediate cash outflow that is later recovered at the end of 6 years.
Ans.
Should be treated as an immediate cash outflow that is later recovered at the end of 6 years.
The Moore Corporation is considering the acquisition of a new machine. The machine can be purchased
for $90,000; it will cost $6,000 to transport to Moore's plant and $9,000 to install. It is estimated that the
machine will last 10 years, and it is expected to have an estimated salvage value of $5,000. Over its 10year life, the machine is expected to produce 2,000 units per year with a selling price of $500 and
combined material and labor costs of $450 per unit. Federal tax regulations permit machines of this type
to be depreciated using the straight-line method over 5 years with no estimated salvage value. Moore
has a marginal tax rate of 40%.
What is the net cash flow for the tenth year of the project that Moore Corporation should use in a
capital budgeting analysis?
$100,000 $81,000 $68,400 $63,000
Ans.
$63,000
The Dickins Corporation is considering the acquisition of a new machine at a cost of $180,000.
Transporting the machine to Dickins' plant will cost $12,000. Installing the machine will cost an
additional $18,000. It has a 10-year life and is expected to have a salvage value of $10,000. Furthermore,
the machine is expected to produce 4,000 units per year with a selling price of $500 and combined
direct materials and direct labor costs of $450 per unit. Federal tax regulations permit machines of this
type to be depreciated using the straight-line method over 5 years with no estimated salvage value.
Dickins has a marginal tax rate of 40%.
What is the net cash outflow at the beginning of the first year that Dickins should use in a capital
budgeting analysis?
$(170,000) $(180,000) $(192,000) . $(210,000)
Ans.
. $(210,000)
The following selected data pertain to a 4-year project being considered by Metro Industries:
ｷ A depreciable asset that costs $1,200,000 will be acquired on January 1. The asset, which is expected
to have a $200,000salvage value at the end of 4 years, qualifies as 3-year property under the Modified
Accelerated Cost Recovery System (MACRS).
ｷ The new asset will replace an existing asset that has a tax basis of $150,000 and can be sold on the
same January 1 for $180,00
ｷ The project is expected to provide added annual sales of 30,000 units at $20. Additional cash
operating costs are: variable, $12 per unit; fixed, $90,000 per year.
ｷ A $50,000 working capital investment that is fully recoverable at the end of the fourth year is required
Metro is subject to a 40% income tax rate and rounds all computations to the nearest dollar. Assume that
any gain or loss affects the taxes paid at the end of the year in which it occurred. The company uses the
net present value method to analyze investments and will employ the following factors and rates.
Period
1
2
3
4
Present Value
of $1 at 12%
0.89
0.89
0.80
1.69
0.71
2.40
0.64
3.04
Present Value of
$1 Annuity at 12%
33%
45
15
7
MACRS
The overall discounted-cash-flow impact of the working capital investment on Metro's project is?
$(2,800) $(18,000) $(50,000) $(59,200)
Ans.
$(18,000)
A company considers a project that will generate cash sales of P50,000 per year. Fixed costs will be
P10,000 per year, variable costs will be 40% of sales, and depreciation of the equipment in the project
will be P5,000 per year. Taxes are 40%. The expected annual cash flow to the company resulting from the
project is
P15,000 P 9,000 P19,000 P14,000
Ans.
P14,000
Metrejean Industries is analyzing a capital investment proposal for new equipment to produce a product
over the next 8 years. At the end of 8 years, the equipment must be removed from the plant and will
have a net book value of $0, a tax basis of $150,000, a cost to remove of $80,000, and scrap salvage
value of $20,000. Metrejean's effective tax rate is 40%. What is the appropriate "end-of-life" cash flow
related to these items that should be used in the analysis?
$90,000 $54,000 $24,000 $(36,000)
Ans.
$24,000
The following selected data pertain to a 4-year project being considered by Metro Industries:
ｷ A depreciable asset that costs $1,200,000 will be acquired on January 1. The asset, which is expected
to have a $200,000salvage value at the end of 4 years, qualifies as 3-year property under the Modified
Accelerated Cost Recovery System (MACRS).
ｷ The new asset will replace an existing asset that has a tax basis of $150,000 and can be sold on the
same January 1 for $180,00
ｷ The project is expected to provide added annual sales of 30,000 units at $20. Additional cash
operating costs are: variable, $12 per unit; fixed, $90,000 per year.
ｷ A $50,000 working capital investment that is fully recoverable at the end of the fourth year is required
Metro is subject to a 40% income tax rate and rounds all computations to the nearest dollar. Assume that
any gain or loss affects the taxes paid at the end of the year in which it occurred. The company uses the
net present value method to analyze investments and will employ the following factors and rates.
Period
1
2
3
4
Present Value
of $1 at 12%
0.89
0.89
0.80
1.69
0.71
2.40
0.64
3.04
Present Value of
$1 Annuity at 12%
33%
45
15
7
MACRS
The discounted, net-of-tax amount that relates to disposal of the existing asset is? $168,000 $169,320
$180,000 $190,680
Ans.
$169,320
In order to increase production capacity, Rovic Industries is considering replacing an existing production
machine with a new technologically improved machine effective January 1, 2014. The following
information is being considered by Gunning Industries:
·
The new machine would be purchased for P160,000 in cash. Shipping and installation would cost
an additional P30,000.
·
The new machine is expected to increase annual sales by 20,000 units at a sales price of P40 per
unit. Incremental operating costs include P30 per unit in variable cost and total fixed costs of P40,000
per year.
·
The investments in the new machine will require an immediate increase in working capital of
P35,000. This cash outflow will be recovered at the end of year 5.
·
Rovic uses straight-line depreciation for financial reporting and tax reporting purposes. The new
machine has an estimated useful life of five years and zero residual value.
·
Rovic is subject to a 40% corporate income tax rate.
Rovic uses the net present value method to analyze investments and will employ the following factors
and rates:
Present Value of an Ordinary
Period Present Value of P1 at 10%
1
.909
.909
2
.826
1.736
3
.751
2.487
4
.683
3.170
5
.621
3.791
Annuity of P1 at 10%
Rovic Industries’ net cash outflow in a capital budgeting decision is?
P190,000 P195,000 P204,525 P225.000
Ans.
P225.000
In order to increase production capacity, Gunning Industries is considering replacing an existing
production machine with a new technologically improved machine effective January 1. The following
information is being considered by Gunning Industries:
ｷ The new machine would be purchased for $160,000 in cash. Shipping, installation, and testing would
cost an additional $30,000.
ｷ The new machine is expected to increase annual sales by 20,000 units at a sales price of $40 per unit.
Incremental operating costs include $30 per unit in variable costs and total fixed costs of $40,000 per
year.
ｷ The investment in the new machine will require an immediate increase in working capital of $35,000.
This cash outflow will be recovered at the end of year 5.ｷ Gunning uses straight-line depreciation for
financial reporting and tax reporting purposes. The new machine has an estimated useful life of 5 years
and zero salvage value.ｷ Gunning is subject to a 40% corporate income tax rate.
Gunning uses the net present value method to analyze investments and will employ the following factors
and rates:
Present Value Present Value of an Ordinary
Period of $1 at 10% Annuity of $1 at 10%
1
.909
.909
2
.826
1.736
3
.751
2.487
4
.683
3.170
5
.621
3.791
The overall discounted cash flow impact of Gunning Industries' working capital investment for the new
production machine would be?
$(7,959) $(10,080) $(13,265) $(35,000)
Ans.
$(13,265)
Whatney Co. is considering the acquisition of a new, more efficient press. The cost of the press is
$360,000, and the press has an estimated 6-year life with zero salvage value. Whatney uses straight-line
depreciation for both financial reporting and income tax reporting purposes and has a 40% corporate
income tax rate. In evaluating equipment acquisitions of this type, Whatney uses a goal of a 4-year
payback period. To meet Whatney's desired payback period, the press must produce a minimum annual
before-tax operating cash savings of
$90,000 $110,000 $114,000 $150,000
Ans.
$110,000
The following selected data pertain to a 4-year project being considered by Metro Industries:
ｷ A depreciable asset that costs $1,200,000 will be acquired on January 1. The asset, which is expected
to have a $200,000salvage value at the end of 4 years, qualifies as 3-year property under the Modified
Accelerated Cost Recovery System (MACRS).
ｷ The new asset will replace an existing asset that has a tax basis of $150,000 and can be sold on the
same January 1 for $180,00
ｷ The project is expected to provide added annual sales of 30,000 units at $20. Additional cash
operating costs are: variable, $12 per unit; fixed, $90,000 per year.
ｷ A $50,000 working capital investment that is fully recoverable at the end of the fourth year is required
Metro is subject to a 40% income tax rate and rounds all computations to the nearest dollar. Assume that
any gain or loss affects the taxes paid at the end of the year in which it occurred. The company uses the
net present value method to analyze investments and will employ the following factors and rates.
Present Value Present Value of
Period of $1 at 12% $1 Annuity at 12%
MACRS
1
0.89
0.89
33%
2
0.80
1.69
45
3
0.71
2.40
15
4
0.64
3.04
7
CMA 0693 4-22
The discounted cash flow for the fourth year MACRS depreciation on the new asset is
$0 $17,920 $21,504. $26,880
Ans.
$21,504.
The following selected data pertain to a 4-year project being considered by Metro Industries:
ｷ A depreciable asset that costs $1,200,000 will be acquired on January 1. The asset, which is expected
to have a $200,000salvage value at the end of 4 years, qualifies as 3-year property under the Modified
Accelerated Cost Recovery System (MACRS).
ｷ The new asset will replace an existing asset that has a tax basis of $150,000 and can be sold on the
same January 1 for $180,00
ｷ The project is expected to provide added annual sales of 30,000 units at $20. Additional cash
operating costs are: variable, $12 per unit; fixed, $90,000 per year.
ｷ A $50,000 working capital investment that is fully recoverable at the end of the fourth year is required
Metro is subject to a 40% income tax rate and rounds all computations to the nearest dollar. Assume that
any gain or loss affects the taxes paid at the end of the year in which it occurred. The company uses the
net present value method to analyze investments and will employ the following factors and rates.
Present Value Present Value of
Period of $1 at 12% $1 Annuity at 12%
MACRS
1
0.89
0.89
33%
2
0.80
1.69
45
3
0.71
2.40
15
4
0.64
3.04
7
The expected incremental sales will provide a discounted, net-of-tax contribution margin over 4 years of
$57,600 $92,160 $273,600 $437,760
Ans.
$437,760
Yipann Corporation is reviewing an investment proposal. The initial cost as well as other related data for
each year are presented in the schedule below. All cash flows are assumed to take place at the end of
the year. The salvage value of the investment at the end of each year is equal to its net book value, and
there will be no salvage value at the end of the investment's life.
Investment Proposal
Annual
Initial Cost
Net After-Tax Annual
Year
and Book Value Cash Flows
Net Income
0
$105,000
0
$0
1
70,000
Yipann uses a 24% after-tax target rate of return for new investment proposals. The discount figures for a
24% rate of return are given.
Present Value of
Present Value of
an Annuity of $1.00
$1.00 Received at
Received at the End
Year
the End of Period
of Each Period
1
.81
.81
2
.65
1.46
3
.52
1.98
4
.42
2.40
5
.34
2.74
6
.28
3.02
7
.22
3.24
The average annual cash inflow at which Yipann would be indifferent to the investment (rounded to the
nearest dollar) is?
$21,000 $30,000 $38,321 $46,667
Ans.
$38,321
On January 1, Crane Company will acquire a new asset that costs $400,000 and is anticipated to have a
salvage value of $30,000 at the end of 4 years. The new asset ｷ Qualifies as 3-year property under the
Modified Accelerated Cost Recovery System (MACRS).ｷ Will replace an old asset that currently has a tax
basis of $80,000and can be sold now for $60,000.ｷ Will continue to generate the same operating
revenues as the old asset ($200,000 per year). However, savings in operating costs will be experienced
as follows: a total of $120,000 in each of the first 3 years and $90,000 in the fourth year. Crane is subject
to a 40% tax rate and rounds all computations to the nearest dollar. Assume that any gain or loss affects
the taxes paid at the end of the year in which it occurred. The company uses the net present value
method to analyze projects using the following factors and rates:
1
2
3
4
Present Value Present Value of
Period of $1 at 14% $1 Annuity at 14% MACRS
.88
.88
33%
.77
1.65
45
.68
2.33
15
.59
2.92
7
The discounted net-of-tax amount that should be factored into Crane Company's analysis for the disposal
transaction is?
$45,760 $60,000 $67,040 $68,000
Ans.
$67,040
Garfield, Inc. is considering a 10-year capital investment project with forecasted revenues of P40,000 per
year and forecasted cash operating expenses of P29,000 per year. The initial cost of the equipment for
the project is P23,000, and Garfield expects to sell the equipment for P9,000 at the end of the tenth year.
The equipment will be depreciated over 7 years. The project requires working capital investments of
P7,000 at its inception and another P5,000 at the end of year 5. Assuming a 40% marginal tax rate, the
expected net cash flows from the project in the tenth year is?
P32,000 P24,000 P20,000 P11,000
Ans.
P24,000
Jasper Company has a payback goal of 3 years on new equipment acquisitions. A new sorter is being
evaluated that costs $450,000 and has a 5-year life. Straight-line depreciation will be used; no salvage is
anticipated. Jasper is subject to 40% income tax rate. To meet the company's payback goal, the sorter
must generate reductions in annual cash operating costs of
$60,000 $100,000 $150,000 $190,000
Ans.
$190,000
Garfield, Inc. is considering a 10-year capital investment project with forecasted revenues of $40,000 per
year and forecasted cash operating expenses of $29,000 per year. The initial cost of the equipment for
the project is $23,000, and Garfield expects to sell the equipment for $9,000 at the end of the tenth year.
The equipment will be depreciated over 7 years. The project requires a working capital investment of
$7,000 at its inception and another $5,000 at the end of year 5. Assuming a 40% marginal tax rate, the
expected net cash flow from the project in the tenth year is?
$32,000 $24,000 $20,000 $11,000
Ans.
$24,000
Lor Industries is analyzing capital investment proposals for new machinery to produce a new product
over the next 10 years. At the end of 10 years, the machinery must be disposed of with a net zero
carrying value but with a residual value of P20,000. It will require some P30,000 to remove the
machinery. The applicable tax rate is 35%. The appropriate “end-of-life” cash flow based on the foregoing
information is:
Inflow of P30,000 Outflow of P6,500 Outflow of P10,000 Outflow of P17,000
Ans.
Outflow of P6,500
An organization has four investments proposals with the following costs and expected cash inflows:
Expected cash Inflows
End of End of End of
Project Cost Year 1 Year 2 Year 3
A
Unknown
P10,000
P10,000
P10,000
B
P20,000
P 5,000P10,000
P15,000
C
P25,000
P15,000
P10,000
P 5,000
D
P25,000
P20,000
Unknown
P20,000
Additional Information
Discount Rate
Number of Periods
Present Value of P1 Due at the End of n Periods (PVF) Present Value of an Annuity of P1 Due at the
End of n Periods (PVFA)
5%
1
0.9524
0.9524
5%
2
0.9070
1.8594
5%
3
0.8638
2.7232
10%
1
0.9091
0.9091
10%
2
0.8264
1.7355
10%
3
0.7513
2.4869
15%
1
0.8696
0.8696
15%
2
0.7561
1.6257
15%
3
0.6575
2.2832
If the discount rate is 5% and the discounted payback period of Project D is exactly 2 years, then the
year 2 cash inflow for Project D is
P 5,890 P10,000 P12,075 P14,301
Ans.
P12,075
Kore Industries is analyzing a capital investment proposal for new equipment to produce a product over
the next 8 years. The analyst is attempting to determine the appropriate "end-of-life" cash flows for the
analysis. At the end of 8 years, the equipment must be removed from the plant and will have a net book
value of zero, a tax basis of $75,000, a cost to remove of $40,000, and scrap salvage value of $10,000.
Kore's effective tax rate is 40%. What is the appropriate "end-of-life" cash flow related to these items
that should be used in the analysis?
$45,000 $27,000 $12,000 $(18,000)
Ans.
$12,000
Transporting the machine to Dickins' plant will cost $12,000. Installing the machine will cost an
additional $18,000. It has a 10-year life and is expected to have a salvage value of $10,000. Furthermore,
the machine is expected to produce 4,000 units per year with a selling price of $500 and combined direct
materials and direct labor costs of $450 per unit. Federal tax regulations permit machines of this type to
be depreciated using the straight-line method over 5 years with no estimated salvage value. Dickins has a
marginal tax rate of 40%.
What is the net cash flow for the third year that Dickins Corporation should use in a capital budgeting
analysis?
$136,800 $136,000 $128,400 $107,400
Ans.
$136,800
Which one of the following statements concerning cash flow determination for capital budgeting
purposes is not correct?
Tax depreciation must be considered because it affects cash payments for taxes.
Book depreciation is relevant because it affects net income.
Sunk costs are not incremental flows and should not be included.
Net working capital changes should be included in cash flow forecasts.
Ans.
Book depreciation is relevant because it affects net income.
A company considers a project that will generate cash sales of $50,000 per year. Fixed costs will be
$10,000 per year, variable costs will be 40% of sales, and depreciation of the equipment in the project
will be $5,000 per year. Taxes are 40%. The expected annual cash flow to the company resulting from the
project is?
$15,000 $9,000 $19,000 $14,000
Ans.
$14,000
The Moore Corporation is considering the acquisition of a new machine. The machine can be purchased
for $90,000; it will cost $6,000 to transport to Moore's plant and $9,000 to install. It is estimated that the
machine will last 10 years, and it is expected to have an estimated salvage value of $5,000. Over its 10year life, the machine is expected to produce 2,000 units per year with a selling price of $500 and
combined material and labor costs of $450 per unit. Federal tax regulations permit machines of this type
to be depreciated using the straight-line method over 5 years with no estimated salvage value. Moore
has a marginal tax rate of 40%.
What is the initial cost of investment?
$(85,000) $(90,000) $(96,000) $(105,000)
Ans.
$(105,000)
If income tax considerations are ignored, how is depreciation used in the following capital budgeting
techniques?
Internal Rate of Return, Included; Accounting. Rate of Return, Excluded.
`Internal Rate of Return, Excluded; Accounting Rate of Return, Included.
Internal Rate of Return, Excluded; Accounting Rate of Return, Excluded.
Internal Rate of Return, Included; Accounting Rate or Return, Included.
Ans.
Internal Rate of Return, Excluded; Accounting Rate of Return, Included.
In order to increase production capacity, Gunning Industries is considering replacing an existing
production machine with a new technologically improved machine effective January 1. The following
information is being considered by Gunning Industries:
ｷ The new machine would be purchased for $160,000 in cash. Shipping, installation, and testing would
cost an additional $30,000.
ｷ The new machine is expected to increase annual sales by 20,000 units at a sales price of $40 per unit.
Incremental operating costs include $30 per unit in variable costs and total fixed costs of $40,000 per
year.
ｷ The investment in the new machine will require an immediate increase in working capital of $35,000.
This cash outflow will be recovered at the end of year 5.ｷ Gunning uses straight-line depreciation for
financial reporting and tax reporting purposes. The new machine has an estimated useful life of 5 years
and zero salvage value.ｷ Gunning is subject to a 40% corporate income tax rate.
Gunning uses the net present value method to analyze investments and will employ the following factors
and rates:
Present Value Present Value of an Ordinary
Period of $1 at 10% Annuity of $1 at 10%
1
.909
.909
2
.826
1.736
3
.751
2.487
4
.683
3.170
5
.621
3.791
The acquisition of the new production machine by Gunning Industries will contribute a discounted netof-tax contribution margin of
$242,624 $303,280 $363,936 $454,920
Ans.
$454,920
The bailout payback method.
Is used by firms with federally insured loans.
Calculates the payback period using the sum of the net cash flows and the salvage value.
Calculates the payback period using the difference between net cash inflow and the salvage value.
Estimates short-term profitability.
Ans.
Calculates the payback period using the sum of the net cash flows and the salvage value.
CMA 0691 4-18
The accounting rate of return
Is synonymous with the internal rate of return.
Focuses on income as opposed to cash flows
Is inconsistent with the divisional performance measure known as return on investment.
Recognizes the time value of money
Ans.
Focuses on income as opposed to cash flows
Mark Company purchased a new machine on January 1 of this year for an amount of P90,000, with an
estimated useful life of 5 years and a residual value of P10,000. The machine will be depreciated using
the straight-line method. The machine is expected to produce cash flows from operations, net of income
taxes, of P36,000 a year in each of the next 5 years. The new machine’s residual value is P20,000 in years
1 and 2, and P15,000 in years 3 and 4 What will be the bailout period (rounded) for this new machine?
1.4 years. 2.2 years 1.9 years 3.4 years
Ans.
1.9 years
A company invested in a new machine that will generate revenues of P35,000 annually for seven years.
The company will have annual operating expenses of P7,000 on the new machine. Depreciation expense,
included in the operating expenses, is P4,000 per year. The expected payback period for the new
machine is 5.2 years. What amount did the company pay for the new machine?
P145,600 P161,200 P166,400 P182,000
Ans.
P166,400
CMA 1291 4-3
Yipann Corporation is reviewing an investment proposal. The initial cost as well as other related data for
each year are presented in the schedule below. All cash flows are assumed to take place at the end of
the year. The salvage value of the investment at the end of each year is equal to its net book value, and
there will be no salvage value at the end of the investment's life.
Investment Proposal
Annual
Initial Cost
Net After-Tax Annual
Year
and Book Value Cash Flows
Net Income
0
$105,000
0
$0
1
70,000 50,000 15,000
2
42,000 45,000 17,000
3
21,000 40,000 19,000
4
7,000 35,000 21,000
5
0
30,000 23,000
Yipann uses a 24% after-tax target rate of return for new investment proposals. The discount figures for
a 24% rate of return are given.
Present Value of
Present Value of
an Annuity of $1.00
$1.00 Received at
Received at the End
Year
the End of Period
of Each Period
1
.81
.81
2
.65
1.46
3
.52
1.98
4
.42
2.40
5
.34
2.74
6
.28
3.02
7
.22
3.24
The accounting rate of return for the investment proposal over its life using the initial value of the
investment is?
36.2% 18.1%. 28.1% 38.1%
Ans.
18.1%.
Nakane Company is planning to purchase a new machine for P500,000. The new machine is expected to
produce cash flows from operations, before income taxes, of P135,000 a year in each of the next five
years. Depreciation of P100,000 a year will be charged to income for each of the next five years. Assume
that the income tax rate is 40%. The payback period would be approximately
2.2 years. 3.4 years. 3.7 years. 4.1 years.
Ans.
4.1 years.
At the beginning of 2018, Garrison Corporation is considering the replacement of an old machine that is
currently being used. The old machine is fully depreciated but can be used by the corporation for an
additional 5 years, that is, through 2022. If Garrison decides to replace the old machine, Picco Company
has offered to purchase it for P60,000 on the replacement date. The old machine would have no residual
value in 2022.
If the replacement occurs, a new machine will be acquired from Hillcrest Industries on January 2, 2018.
The purchase price of P1 million for the new machine will be paid in cash at the time of replacement.
Because of the increased efficiency of the new machine, estimated annual cash savings of P300,000 will
be generated through 2022, the end of its expected useful life. The new machine is not expected to have
any residual value at the end of 2022. All operating cash receipts, operating cash expenditures, and
applicable tax payments and credits are assumed to occur at the end of the year. Garrison employs the
calendar year for reporting purposes.
Discount tables for several different interest rates that are to be used in any discounting calculations are
given below.
Present value of P1.00 Received at End of Period
Periods
9%
12%
15%
18%
21%
1
.92
.89
.87
.85
.83
2
3
.84
.77
4
5
.80
.71
.76
.65
.71
.65
.72
.61
.64
.57
.68
.56
.57
.50
.51
.44
.47
.39
Present Value of an Annuity of P1.00
Received at the End of Each Period
Periods 9%
12%
15%
18%
21%
1
.92
.89
.87
.85
.83
2
1.76
1.69
1.63
1.57
1.51
3
2.53
2.40
2.28
2.18
2.07
4
3.24
3.04
2.85
2.69
2.54
5
3.89
3.61
3.35
3.13
2.93
The payback period to replace the old machine with the new machine is
1.14 years 2.78 years. 3.13 years 3.33 years
Ans.
3.13 years
MS Trucking is considering the purchase of a new piece equipment that has a net initial investment with
a present value of $300,000. The equipment has an estimated useful life of 3 years. For tax purposes, the
equipment will be fully depreciated at rates of 30%, 40%, and 30% in years one, two, and three,
respectively. The new machine is expected to have a $20,000 salvage value. The machine is expected to
save the company $170,000 per year in operating expenses. MS Trucking has a 40% marginal income tax
rate and a 16% cost of capital. Discount rates for a 16% rate are:
Present Value of an
Ordinary Annuity of $1 Present Value of $1
Year 1 .862
.862
Year 2 1.605 .743
Year 3 2.246 .641
Assume the same facts as above, except that the salvage value at the end of the investment's useful life
is zero. What is the new payback period?
2.84 years 1.76 years 2.08 years 2.09 years
Ans.
2.09 years
Amaro Hospital, a nonprofit institution not subject to income taxes, is considering the purchase of new
equipment costing P20,000, in order to achieve cash savings of P5,000 per year in operating costs. The
equipment’s estimated useful life is ten years, with no residual value. Amaro’s cost of capital is 14%. For
ten periods of 14%, the present value of P1 is 0.270, while the present value of an ordinary annuity of P1
is 5.216.
How much is the accounting rate of return based on Amaro’s initial investment in the new equipment?
27% 25% 15% 14%
Ans.
15%
CMA 1290 4-17
The technique that measures the number of years required for the after-tax cash flows to recover the
initial investment in a project is called the?
Net present value method.
Payback method.
Profitability index method
Accounting rate of return method.
Ans.
Payback method.
Phillips Company is considering the acquisition of a new machine that would cost P66,000, has an
expected life of 6 years, and an expected salvage value of P16,000. The company expects the machine to
provide annual incremental income before taxes of P7,200. Phillips has a tax rate of 30%. If Phillips uses
average values in its calculations, which one of the following will be the average accounting rate of
return on the machine?
10.08% 10.90% 12.29% 14.40%
Ans.
12.29%
CMA 0691 4-16
Fitzgerald Company is planning to acquire a $250,000 machine that will provide increased efficiencies,
thereby reducing annual operating costs by $80,000. The machine will be depreciated by the straight-line
method over a 5-year life with no salvage value at the end of 5 years. Assuming a 40% income tax rate,
the machine's payback period is?
3.13 years 3.21 years 3.68 years 4.81 years
Ans.
3.68 years
An investment project is expected to yield P10,000 in annual revenues, will incur P2,000 in fixed cost per
year, and requires an initial inventory of P5,000. Given a cost of goods sold of 60% of sales and ignoring
taxes, what is the payback period in years?
2.50 5.00 2.00 1.25
Ans.
2.50
MS Trucking is considering the purchase of a new piece equipment that has a net initial investment with
a present value of $300,000. The equipment has an estimated useful life of 3 years. For tax purposes, the
equipment will be fully depreciated at rates of 30%, 40%, and 30% in years one, two, and three,
respectively. The new machine is expected to have a $20,000 salvage value. The machine is expected to
save the company $170,000 per year in operating expenses. MS Trucking has a 40% marginal income tax
rate and a 16% cost of capital. Discount rates for a 16% rate are:
Present Value of an
Ordinary Annuity of $1 Present Value of $1
Year 1 .862
.862
Year 2 1.605 .743
Year 3 2.246 .641
The payback period for this investment is
2.84 years 1.76 years 2.08 years 3.00 years
Ans.
2.08 years
CMA 0696 4-25
Jorelle Company's financial staff has been requested to review a proposed investment in new capital
equipment. Applicable financial data is presented below. There will be no salvage value at the end of the
investment's life and, due
to realistic depreciation practices, it is estimated that the salvage value and net book value are equal at
the end of
each year. All cash flows are assumed to take place at the end of each year. For investment proposals,
Jorelle uses a 12% after-tax target rate of return.
Discounted Factors for a 12% Rate of Return
Present Value of an
Present Value of $1.00 Annuity of $1.00
Received at the End
Received at the
Year
of Each Period End of Each Period
1
.89
.89
2
.80
1.69
3
.71
2.40
4
.64
3.04
5
.57
3.61
6
.51
4.12
The traditional payback period for the investment proposal is
Over 5 years 2.23 years 1.65 years 2.83 years
Ans.
2.23 years
A proposed investment is not expected to have any salvage value at the end of its 5-year life. For present
value purposes, cash flows are assumed to occur at the end of each year. The company uses a 12% aftertax target rate of return.
Purchase Cost Annual Net After
Annual
Year
and Book Value Tax Cash Flows Net Income
0
$500,000
$ 0 $ 0
1
336,000
240,000
70,000
2
200,000
216,000
78,000
3
100,000
192,000
86,000
4
36,000 168,000
94,000
5
0
144,000
102,000
Discount Factors for a 12% Rate of Return
Present Value of $1 at Present Value of an Annuity of
Year
the End of Each Period $1 at the End of Each Period
1
.89
.89
2
.80
1.69
3
.71
2.40
4
.64
3.04
5
.57
3.61
6
.51
4.12
The accounting rate of return based on the average investment is ?
84.9% 34.4% 40.8% 12%
Ans.
34.4%
The payback capital budgeting technique considers
Income over entire life of Project
No
Yes
Yes
No
Ans.
No
Time value of money
No
No
Yes
Yes
No
Don Adams Breweries is considering an expansion project with an investment of $1,500,000. The
equipment will be depreciated to zero salvage value on a straight-line basisover 5 years. The expansion
will produce incremental operating revenue of $400,000 annually for 5 years. The company's
opportunity cost of capital is 12%. Ignore taxes.
What is the book (accounting) rate of return of the investment?
6.67% 13.33% 16.67% 26.67%
Ans.
13.33%
The Hablot Inc. is planning to spend P600,000 for a machine that it will depreciate on a straight-line basis
over a ten-year period with no terminal disposal price. The machine will generate cash flow from
operations of P120,000 a year. Ignoring income taxes, what is the accounting rate of return on the net
initial investment?
5% 12% 10% 15%
Ans.
10%
Henderson Inc. has purchased a new fleet of trucks to deliver its merchandise. The trucks have a useful
life of 8 years and cost a total of $500,000. Henderson expects its net increase in after-tax cash flow to be
$150,000 in Year 1, $175,000 in Year 2, $125,000 in Year 3, and $100,000 in each of the remaining years.
Assume the net cash flow to be $130,000 a year. What is the payback time for the fleet of trucks?
3 years 3.15 years 3.85 years 4 years
Ans.
3.85 years
A machine costing P1,000 produces total cash inflows of P1,400 over 4 years. Determine the payback
period given the following cash flows:
After-tax
Cumulative
Year
Cash Flows
Cash Flows
1
P400
P 400
2
300
700
3
500
1,200
4
200
1,400
2 years 2.60 years 2.86 years 3 years
Ans.
2.60 years
Major Corp. is considering the purchase of a new machine for P5,000 that will have an estimated useful
life of five years and no salvage value. The machine will increase Major’s after-tax cash flow by P2000
annually for five years. Major uses the straight-line method of depreciation and has an incremental
borrowing rate of 10%. The present value factors for 10% are as follows:
Ordinary annuity with five payments
3.79
Annuity due for five payment 4.17
Using the payback method, how many years will it take to pay back Major’s initial investment in the
machine?
2.50 5.00 7.58 8.34
Ans.
2.50
CMA 1294 4-20
The length of time required to recover the initial cash outlay of a capital project is determined by using
the
Discounted cash flow method.
Payback method.
Weighted net present value method
Accounting rate of return
Ans.
Payback method.
Henderson Inc. has purchased a new fleet of trucks to deliver its merchandise. The trucks have a useful
life of 8 years and cost a total of $500,000. Henderson expects its net increase in after-tax cash flow to be
$150,000 in Year 1, $175,000 in Year 2, $125,000 in Year 3, and $100,000 in each of the remaining years.
What is the payback reciprocal for the fleet of trucks?
29% 25% 24% 20%
Ans.
29%
CMA 1291 4-1
Yipann Corporation is reviewing an investment proposal. The initial cost as well as other related data for
each year are presented in the schedule below. All cash flows are assumed to take place at the end of
the year. The salvage value of the investment at the end of each year is equal to its net book value, and
there will be no salvage value at the end of the investment's life.
Investment Proposal
Annual
Initial Cost
Net After-Tax
Year
and Book Value Cash Flows
0
$105,000
0
$0
1
70,000 50,000 15,000
2
42,000 45,000 17,000
3
21,000 40,000 19,000
4
7,000 35,000 21,000
5
0
30,000 23,000
Annual
Net Income
Yipann uses a 24% after-tax target rate of return for new investment proposals. The discount figures for
a 24% rate of return are given.
Present Value of
Present Value of
an Annuity of $1.00
$1.00 Received at
Received at the End
Year
the End of Period
of Each Period
1
.81
.81
2
.65
1.46
3
.52
1.98
4
.42
2.40
5
.34
2.74
6
.28
3.02
7
.22
3.24
The traditional payback period for the investment proposal is
8.75 years 1.933 years 2.250 years Over 5 years
Ans.
2.250 years
Which of the following methods measures the cash inflows and outflows of a project as if they occurred
at a single point in time?
Cash flow based payback method.
Capital budgeting
Payback method.
Discounted cash flow.
Ans.
Discounted cash flow.
All of the following refer to the discount rate used by a firm in capital budgeting except:
Hurdle rate
Required rate of return
Opportunity cost
Opportunity cost of capital
Ans.
Opportunity cost
Which one of the following statements about the payback method of investments analysis is correct?
Does not consider the time value of money.
Considers cash flows after the payback has been reached.
Uses discounted cash flow techniques.
Is rarely used in practice.
Ans.
Does not consider the time value of money.
A project has an initial outlay of P1,000. The projected cash inflows earned evenly over each year are:
Year 1 P200
Year 2 200
Year 3 400
Year 4 400
What is the investment's payback period?
4.0 years 3.5 years 3.4 years 3.0 years
Ans.
3.5 years
Sweets, Etc., Inc. plans to undertake a capital expenditure requiring P2 million cash outlay. Below are the
projected after-tax cash inflows for the five-year period covering the useful life. The company’s tax rate is
35%
Year
P000
1
600
2
700
3
480
4
400
5
400
The founder and president of the company believes that the best gauge for capital expenditures is cash
payback period and that the recovery period should not be more than 75% of the useful life of the
project or the asset. Should the company undertake the project?
No, since the payback period is 4 years or 80% of the useful life of the project. Yes, since the payback
period is 3.55 years or 71% of the useful life of the project No, since the payback period extends beyond
the life of the project.
Yes, since the payback period is 4 years and still shorter than the useful life of the project.
Ans.
Yes, since the payback period is 3.55 years or 71% of the useful life of the project
Rex Company is considering an investment in a new plant which will entail an immediate capital
expenditure of $4,000,000. The plant is to be depreciated on a straight-line basis over 10 years to zero
salvage value. Operating income (before depreciation and taxes) is expected to be $800,000 per year
over the 10-year life of the plant. The opportunity cost of capital is 14%. Assume that there are no taxes.
What is the book (or accounting) rate of return for the investment?
10% 20% 28% 35%
Ans.
20%
The method of project selection which considers the time value of money in a capital budgeting decision
is accomplished by computing the
Accounting rate of return on initial investment.
Payback period.
Accounting rate of return on average investment.
Discounted cash flow.
Ans.
Discounted cash flow.
CMA 1294 4-24
The method that divides a project's annual after-tax net income by the average investment cost to
measure the estimated performance of a capital investment is the Internal rate of return method.
Accounting rate of return method.
Payback method.
Net present value (NPV) method.
Ans.
Accounting rate of return method.
Logg Company is planning to buy a coin-operated machine costing P40,000. For tax purposes, this
machine will be depreciated over a five-year period using the straight-line method and no residual value.
Assume that the investment tax credit is not applicable to this purchase. Logg estimates that this
machine will yield an annual cash inflow, net of depreciation and income taxes, of P12,000. At the
following discount rates, the net present values of the investment are:
Discount
Net present
rate
value
12%
+ P3,258
14%
+ 1,197
16%
708
18%
- 2,474
Logg’s desired rate of return on its investment is 12%.
Logg’s expected payback period for its investment in this machine is
2.0 years 3.0 years 3.3 years 5.0 years
Ans.
3.3 years
Given these data:
·
Net after tax inflows are: P24,000 for year 1, P30,000 for year 2, P36,000 for year 3, and P30,000
for year 4.
·
Initial investment outlay is P60,000.
Cost of capital is 18%.
Determine the payback period for this investment:
2.5 years 2.17 years 3.00 years 3.17 years
Ans.
2.17 years
It is assumed that cash flows are reinvested at the rate earned by the investment in which of the
following capital budgeting techniques?
Internal rate of return
Yes
Yes
No
No
Ans.
Yes
Net present value
Yes
No
No
Yes
Yes
Which one of the following methods of evaluating potential capital projects would take into account
depreciation expense that was nondeductible for tax purposes?
Payback period approach.
Discounted payback period approach.
Accounting rate of return approach.
Net present value approach.
Ans.
Accounting rate of return approach.
The capital budgeting model that is ordinarily considered the best model for long-range decision making
is the
Payback model
Accounting rate of return model.
Unadjusted rate of return model.
Discounted cash flow model.
Ans.
Discounted cash flow model.
A proposed project has an expected economic life of eight years. In the calculation of the net present
value of the proposed project, residual value would be
Excluded from the calculation of the net present value.
Included in a cash inflow at the estimated residual value.
Included as a cash inflow at the present value of the estimated residual value.
Included as a cash inflow at the future amount of the estimated residual value.
(aicpa)
Ans.
Included as a cash inflow at the present value of the estimated residual value.
You are the treasurer of Mayaman Corporation. The company is considering a proposed project which
has an expected economic life of seven years. Net present value is the capital budgeting technique the
president wants you to use. Residual value of the project would be. Treated as cash inflow at estimated
residual value.
Treated as cash inflow at its present value.
Irrelevant cash flow item.
Treated as cash inflow at the future value.
Ans.
Treated as cash inflow at its present value.
The Apex Company is evaluating a capital budgeting proposal for the current year. The relevant data
follow:
Present value of an Annuity of P1
Year
in Arrears at 15%
1
P0.870
2
1.626
3
2.284
4
2.856
5
3.353
6
3.785
The initial equipment investment would be P30,000. Apex would depreciate the equipment for tax
purposes on a straight-line basis over six years with a zero terminal disposal price. The before-tax annual
cash inflow arising from this investment is P10,000. The income tax rate is 40%, and income tax is paid
the same year as incurred. The after-tax required rate of return is 15%.
What is the after-tax payback period (in years) for Apex’s capital budgeting proposal?
5 3.75 3 2
Ans.
3.75
The Folk Company is planning to purchase a new machine, which it will depreciate on a straight-line basis
over a ten-year period with no residual value and a full year’s depreciation in the year of acquisition.
The new machine is expected to produce cash flow from operations, net of income taxes, of P66,000 a
year in each of the next ten years. The accounting (book value) rate of return on the initial investment is
expected to be 12%. How much will the new machine cost?
P300,000 P550,000 P660,000 P792,000
Ans.
P300,000
Lin Co. is buying machinery it expects will increase average annual operating income by P40,000. The
initial increase in the required investment is P60,000, and the average increase in required investment is
P30,000. To compute the accrual accounting rate of return, what amount should be used as the
numerator in the ratio?
P20,000 P30,000 P40,000 P60,000
Ans.
P40,000
Tam Co. is negotiating for the purchase of equipment that would cost P100,000, with the expectation
that P20,000 per year could be saved in after-tax cash costs if the equipment is acquired. The
equipment's estimated useful life is 10 years, with no residual value, and it would be depreciated by the
straight-line method. Tam's predetermined minimum desired rate of return is 12%. Present value of an
annuity of 1 at 12% for 10 periods is 5.65. Present value of 1 due in 10 periods at 12% is .322.
The accrual accounting rate of return based on the initial investment is
30% 20% 12% 10%
Ans.
10%
Henderson Inc. has purchased a new fleet of trucks to deliver its merchandise. The trucks have a useful
life of 8 years and cost a total of $500,000. Henderson expects its net increase in after-tax cash flow to be
$150,000 in Year 1, $175,000 in Year 2, $125,000 in Year 3, and $100,000 in each of the remaining years.
Ignoring the time value of money, how long will it take Henderson to recover the amount of investment?
3.5 years 4.0 years 4.2 years 5 years
Ans.
3.5 years
A capital budgeting method that provides a rough approximation of an investment’s profitability:
Average rate of return method.
Net present value method.
Payback period method.
Internal rate of return method.
Ans.
Average rate of return method.
CMA 1292 4-11
The bailout payback method
Incorporates the time value of money.
Equals the recovery period from normal operations.
Eliminates the disposal value from the payback calculation.
Measures the risk if a project is terminated.
Ans.
Measures the risk if a project is terminated.
CMA 0696 4-23
Jorelle Company's financial staff has been requested to review a proposed investment in new capital
equipment. Applicable financial data is presented below. There will be no salvage value at the end of the
investment's life and, due
to realistic depreciation practices, it is estimated that the salvage value and net book value are equal at
the end of
each year. All cash flows are assumed to take place at the end of each year. For investment proposals,
Jorelle uses a 12% after-tax target rate of return.
Discounted Factors for a 12% Rate of Return
Present Value of an
Present Value of $1.00 Annuity of $1.00
Received at the End
Received at the
Year
of Each Period End of Each Period
1
.89
.89
2
.80
1.69
3
.71
2.40
4
.64
3.04
5
.57
3.61
6
.51
4.12
The accounting rate of return on the average investment proposal is
12.0% 17.2% 28.0% 34.4%
Ans.
34.4%
Don Adams Breweries is considering an expansion project with an investment of $1,500,000. The
equipment will be
depreciated to zero salvage value on a straight-line basisover 5 years. The expansion will produce
incremental operating revenue of $400,000 annually for 5 years. The company's opportunity cost of
capital is 12%. Ignore taxes.
Don Adams Breweries is considering an expansion project with an investment of $1,500,000. The
equipment will be
depreciated to zero salvage value on a straight-line basisover 5 years. The expansion will produce
incremental operating revenue of $400,000 annually for 5 years. The company's opportunity cost of
capital is 12%. Ignore taxes.
What is the payback period of the project?
2 years 2.14 years 3.75 years 5 years
Ans.
3.75 years
The following statements refer to the accounting rate of return (ARR):
1.
The ARR is based on the actual basis, not cash basis.
2.
The ARR does not consider the time value of money.
3.
The profitability of the project is not considered.
From the above statements, which at considered limitations of the ARR concept?
Statements 2 and 3 only.
Statements 3 and 1 only.
All the 3 statements
Statements 1 and 2 only.
Ans.
Statements 1 and 2 only.
The Dickins Corporation is considering the acquisition of a new machine at a cost of $180,000.
Transporting the machine to Dickins' plant will cost $12,000. Installing the machine will cost an
additional $18,000. It has a 10-year life and is expected to have a salvage value of $10,000. Furthermore,
the machine is expected to produce 4,000 units per year with a selling price of $500 and combined direct
materials and direct labor costs of $450 per unit. Federal tax regulations permit machines of this type to
be depreciated using the straight-line method over 5 years with no estimated salvage value. Dickins has a
marginal tax rate of 40%.
What is the approximate payback period on the new machine?
1.05 years 1.54 years 1.33 years 2.22 years
Ans.
1.54 years
Which one of the following statements about the payback method of investments analysis is correct?
The payback method
Does not consider the time value of money.
Considers cash flows after the payback has been reached.
Uses discounted cash flow techniques.
Is rarely used in practice.
Ans.
Does not consider the time value of money.
The payback reciprocal can be used to approximate a project's.
Profitability index
Net present value
Accounting rate of return if the cash flow pattern is relatively stable.
Internal rate of return if the cash flow pattern is relatively stable.
Ans.
Internal rate of return if the cash flow pattern is relatively stable.
CMA 0693 4-27
The payback reciprocal can be used to approximate a project’s
Net present value.
Accounting rate of return if the cash flow pattern is relatively stable.
Payback period.
Internal rate of return if the cash flow pattern is relatively stable.
Ans.
Internal rate of return if the cash flow pattern is relatively stable.
CMA 1290 4-15
The technique that measures the estimated performance of a capital investment by dividing the project's
annual after-tax net income by the average investment cost is called the
Average rate of return method.
Internal rate of return method.
Capital asset pricing model.
Accounting rate of return method.
Ans.
Accounting rate of return method.
CMA 0695 4-6
McLean Inc. is considering the purchase of a new machine that will cost $160,000. The machine has an
estimated useful life of 3 years. Assume that 30% of the depreciable base will be depreciated in the first
year, 40% in the second year, and 30% in the third year. The new machine will have a $10,000 resale
value at the end of its estimated useful life. The machine is expected to save the company $85,000 per
year in operating expenses. McLean uses a 40% estimated income tax rate and a 16% hurdle rate to
evaluate capital projects.
Discount rates for a 16% rate are as follows:
Present Value of $1
Present Value of an Ordinary Annuity of $1
Year 1 .862
.862
Year 2 .743
1.605
Year 3 .641
2.246
The payback period for this investment would be?
1.88 years 3.00 years 2.23 years 1.62 years
Ans.
2.23 years
CMA 1294 4-25
The capital budgeting model that is generally considered the best model for long-range decision making
is the
Payback model
Accounting rate of return model
Unadjusted rate of return model
Discounted cash flow model
Ans.
Discounted cash flow model
Logg Company is planning to buy a coin-operated machine costing P40,000. For tax purposes, this
machine will be depreciated over a five-year period using the straight-line method and no residual value.
Assume that the investment tax credit is not applicable to this purchase. Logg estimates that this
machine will yield an annual cash inflow, net of depreciation and income taxes, of P12,000. At the
following discount rates, the net present values of the investment are:
Discount
Net present
rate
value
12%
+ P3,258
14%
+ 1,197
16%
708
18%
- 2,474
Logg’s desired rate of return on its investment is 12%.
Logg’s accounting rate of return on its initial investment in this machine is expected to be
30% 15% 12% 10%
Ans.
10%
A company purchased a new machine to stamp the company logo on its products. The cost of the
machine was P250,000, and it has an estimated useful life of 5 years with an expected residual value at
the end of its useful life of P50,000. The company uses the straight-line depreciation method.
The machine is expected to save P125,000 annually in operating costs. The company’s tax rate is 40%,
and it uses a 10% discount rate to evaluate capital expenditures.
Year
Present value of P1
1
.909
.909
2
.826
3
.751
4
.683
5
.621
Present Value of an Ordinary Annuity of P1
1.735
2.486
3.169
3.790
What is the accounting rate of return based on the average investment in the new stamping machine?
20.4% 34.0% 40.8% 51.0%
Ans.
34.0%
CMA 1295 4-13
Willis Inc. has a cost of capital of 15% and is considering the acquisition of a new machine which costs
$400,000 and has a useful life of 5 years. Willis projects that earnings and cash flow will increase as
follows:
Net
After-Tax
Year
Earnings
Cash Flow
1
$100,000
$160,000
2
100,000
140,000
3
100,000
100,000
4
100,000
100,000
5
200,000
100,000
What is the payback period of this investment?
1.50 years 3.00 years 3.33 years 4.00 years
Ans.
3.00 years
A company purchased a new machine to stamp the company logo on its products. The cost of the
machine was P250,000, and it has an estimated useful life of 5 years with an expected residual value at
the end of its useful life of P50,000. The company uses the straight-line depreciation method.
The machine is expected to save P125,000 annually in operating costs. The company’s tax rate is 40%,
and it uses a 10% discount rate to evaluate capital expenditures.
Year
Present value of P1
1
.909
.909
2
.826
Present Value of an Ordinary Annuity of P1
1.735
3
4
5
.751
.683
.621
2.486
3.169
3.790
What is the traditional payback period for the new stamping machine?
2.00 years 2.63 years 2.75 years 2.94 years
Ans.
2.75 years
All of the following items are included in discounted cash flow analysis, except:
Future operating cash savings.
The disposal prices of the current and future assets.
The future assets depreciation.
The tax effects of future assets depreciation.
Ans.
The future assets depreciation.
The Apex Company is evaluating a capital budgeting proposal for the current year. The relevant data
follow:
Present value of an Annuity of P1
Year
in Arrears at 15%
1
2
3
4
5
6
P0.870
1.626
2.284
2.856
3.353
3.785
The initial equipment investment would be P30,000. Apex would depreciate the equipment for tax
purposes on a straight-line basis over six years with a zero terminal disposal price. The before-tax annual
cash inflow arising from this investment is P10,000. The income tax rate is 40%, and income tax is paid
the same year as incurred. The after-tax required rate of return is 15%.
What is the after-tax accrual accounting rate of return on Apex’s initial equipment investment?
10 % 16 2/3 % 26 2/3% 33 1/3%
Ans.
10 %
The method that divides a project’s annual after tax profit by the average investment cost to measure
the estimated performance of a capital investment is the
Internal rate of return method.
Accounting rate of the return method.
Payback method.
Net present value (NPV) method.
Ans.
Accounting rate of the return method.
When using one of the discounted cash flow methods to evaluate the desirability of a capital budgeting
project, which of the following factors generally is not important?
The method of financing the project under consideration.
The impact of the project on income taxes to be paid.
The timing of cash flows relating to the project.
The amount of cash flows relating to the project.
Ans.
The method of financing the project under consideration.
Which of the following is necessary in order to calculate the payback period for a project? Useful life
Minimum desired rate of return.
Net present value.
Annual cash flow.
Ans.
Annual cash flow.
The payback reciprocal is an estimate of the internal rate of return. The Bravo, Inc. is considering the
acquisition of a merchandise picking system to improve customer service. Annual cash returns on
investment cost of P1.2 million are P220,000. Useful life is estimated at 8 years. The company’s cost of
capital is 14% and income tax rate is 35%. Calculate Bravo, Inc.’s payback reciprocal for this investment:
20.5% 18.3% 11.9% 22.2%
Ans.
18.3%
If it is determined that a project investment is expected to generate P1.20 in present value for each
P1.00 invested, which one of the following was most likely used to reach that conclusion?
Net present value approach.
Profitability index approach.
Internal rate of return approach.
Payback period approach.
Ans.
Profitability index approach.
Which one of the following methods of evaluating investment projects is most likely to be used to rank
projects competing for limited capital investment funds?
Payback period method.
Net present value method.
Internal rate of return method.
Profitability index method.
Ans.
Profitability index method.
CMA 0695 4-4
The profitability index (present value index)
Represents the ratio of the discounted net cash outflows to cash inflows.
Is the relationship between the net discounted cash inflows less the discounted cash outflows divided by
the discounted cash outflows.
Is calculated by dividing the discounted profits by the cash outflows.
Is the ratio of the discounted net cash inflows to discounted cash outflows.
Ans.
Is the ratio of the discounted net cash inflows to discounted cash outflows.
An organization has four investments proposals with the following costs and expected cash inflows:
Expected cash Inflows
End of End of End of
Project Cost Year 1 Year 2 Year 3
A
Unknown
P10,000
P10,000
P10,000
B
P20,000
P 5,000P10,000
P15,000
C
P25,000
P15,000
P10,000
P 5,000
D
P30,000
P20,000
Unknown
P20,000
Additional Information:
Discount Rate Number of Periods
Present Value of P1 Due at the End of n Periods (PVF) Present
Value of an Annuity of P1 Due at the End of n Periods (PVFA)
5%
1
0.9524 0.9524
5%
2
0.9070 1.8594
5%
3
0.8638 2.7232
10%
0.9091 0.9091
10%
2
0.8264 1.7355
10%
3
0.7513 2.4869
15%
1
0.8696 0.8696
15%
2
0.7561 1.6257
15%
3
0.6575 2.2832
If Project A has an internal rate of return (IRR) of 15%, it has a cost of?
P 8,696 P22,832 P24,869 P27,232
Ans.
P22,832
A proposed investment is not expected to have any salvage value at the end of its 5-year life. For present
value purposes, cash flows are assumed to occur at the end of each year. The company uses a 12% aftertax target rate of return.
Purchase Cost Annual Net After
Annual
Year
and Book Value Tax Cash Flows Net Income
0
$500,000
$ 0 $ 0
1
336,000
240,000
70,000
2
200,000
216,000
78,000
3
100,000
192,000
86,000
4
36,000 168,000
94,000
5
0
144,000
102,000
Discount Factors for a 12% Rate of Return
Present Value of $1 at Present Value of an Annuity of
Year
the End of Each Period $1 at the End of Each Period
1
.89
.89
2
.80
1.69
3
.71
2.40
4
.64
3.04
5
.57
3.61
6
.51
4.12
Which statement about the internal rate of return of the investment is true?
The IRR is exactly 12%.
The IRR is over 12%.
The IRR is under 12%.
No information about the IRR can be determined.
Ans.
The IRR is over 12%.
In order to increase production capacity, Rovic Industries is considering replacing an existing production
machine with a new technologically improved machine effective January 1, 2014. The following
information is being considered by Gunning Industries:
•
The new machine would be purchased for P160,000 in cash. Shipping and installation would cost
an additional P30,000.
•
The new machine is expected to increase annual sales by 20,000 units at a sales price of P40 per
unit. Incremental operating costs include P30 per unit in variable cost and total fixed costs of P40,000
per year.
•
The investments in the new machine will require an immediate increase in working capital of
P35,000. This cash outflow will be recovered at the end of year 5.
•
Rovic uses straight-line depreciation for financial reporting and tax reporting purposes. The new
machine has an estimated useful life of five years and zero residual value.
•
Rovic is subject to a 40% corporate income tax rate.
Rovic uses the net present value method to analyze investments and will employ the following factors
and rates:
Present Value of an Ordinary
Period Present Value of P1 at 10%
Annuity of P1 at 10%
1
.909
909
2
.826
1.736
3
.751
2.487
4
.683
3.170
5
.621
3.791
The internal rate of return of Project A, to the nearest full percentage point, is?
10% 15% 25% 100%
Ans.
100%
A company purchases an item for P43,000. The salvage value of the item is P3,000. The cost of capital is
8%. Pertinent information related to this purchase is as follows:
Net Cash Flow Present Value Factor at 8%
Year 1
P10,000
0.926
Year 2
15,000
0.857
Year 3
20,000
0.794
Year 4
27,000
0.735
What is the discounted payback period in years?
3.10 3.25 2.90 3.14
Ans.
3.25
The accountant of Ronier, Inc. has prepared an analysis of a proposed capital project using discounted
cash flow techniques. One manager has questioned the accuracy of the results because the discount
factors employed in the analysis have assumed the cash flows occurred at the end of the year when the
cash flows actually occurred uniformly throughout each year. The net present value calculated by the
accountant will
Not be in error.
Be slightly overstated.
Be unusable for actual decision making.
Be slightly understated but usable.
Ans.
Be slightly understated but usable.
CMA 1286 5-4
A manager wants to know the effect of a possible change in cash flows on the net present value of a
project. The
technique used for this purpose is?
Sensitivity analysis.
Risk analysis.
Cost behavior analysis.
Return on investment analysis.
Ans.
Sensitivity analysis.
What is the formula for calculating the profitability index of a project?
Subtract actual after-tax net income from the minimum required return in pesos.
Divide the present value of the annual after-tax cash flows by the original cash invested in the project.
Divide the initial investment for the project by the net annual cash inflows.
Multiply net profit margin by asset turnover.
Ans.
Divide the present value of the annual after-tax cash flows by the original cash invested in the project.
A project's net present value, ignoring income tax considerations, is normally affected by the
Proceeds from the sale of the asset to be replaced.
Carrying amount of the asset to be replaced by the project.
Amount of annual depreciation on the asset to be replaced.
Amount of annual depreciation on fixed assets used directly on the project.
Ans.
Proceeds from the sale of the asset to be replaced.
CMA 0691 4-19
The internal rate of return on an investment
Usually coincides with the company's hurdle rate.
Disregards discounted cash flows.
May produce different rankings from the net present value method on mutually exclusive projects.
Would tend to be reduced if a company used an accelerated method of depreciation for tax purposes
rather than the straight-line method.
Ans.
May produce different rankings from the net present value method on mutually exclusive projects.
The NPV of a project has been calculated to be $215,000. Which one of the following changes in
assumptions would decrease the NPV?
Decrease the estimated effective income tax rate.
Decrease the initial investment amount.
Extend the project life and associated cash inflows.
Increase the discount rate.
Ans.
Increase the discount rate.
Capital Investment Inc. uses a 12% hurdle rate for all capital expenditures and has done the following
analysis for four project for the upcoming year:
Project 1
Project 2
Project 3
Project 4
Initial capital outlay
P200,000
P248,000
P248,000
P272,000
Annual net cash inflows
Year 1 65,000 100,000
80,000 95,000
Year 2 70,000 135,000
95,000 125,000
Year 3 80,000 90,000 90,000 90,000
Year 4 40,000 65,000 80,000 60,000
Net present Value
( 3,798)
4,276 14,064 14,662
Profitability index
98%
101% 106% 105%
Internal rate of return 11%
13%
14%
15%
Which projects (s) should Capital Investment Inc. undertake during the upcoming year if it has only
P300,000 of capital funds available?
Project 1 Project 2, 3, and 4 Projects 3 and 4. Project 3
Ans.
Project 3
A proposed investment is not expected to have any salvage value at the end of its 5-year life. For present
value purposes, cash flows are assumed to occur at the end of each year. The company uses a 12% aftertax target rate of return.
Purchase Cost Annual Net After
Annual
Year
and Book Value Tax Cash Flows Net Income
0
$500,000
$ 0 $ 0
1
336,000
240,000
70,000
2
200,000
216,000
78,000
3
100,000
192,000
86,000
4
36,000 168,000
94,000
5
0
144,000
102,000
Discount Factors for a 12% Rate of Return
Present Value of $1 at Present Value of an Annuity of
Year
the End of Each Period $1 at the End of Each Period
1
.89
.89
2
.80
1.69
3
.71
2.40
4
.64
3.04
5
.57
3.61
6
.51
4.12
The profitability index is
.61 .42 .86 1.425
Ans.
1.425
Capital Investment Inc. uses a 12% hurdle rate for all capital expenditures and has done the following
analysis for four project for the upcoming year:
Project 1
Project 2
Project 3
Project 4
Initial capital outlay
P200,000
P248,000
P248,000
P272,000
Annual net cash inflows
Year 1 65,000 100,000
80,000 95,000
Year 2 70,000 135,000
95,000 125,000
Year 3 80,000 90,000 90,000 90,000
Year 4 40,000 65,000 80,000 60,000
Net present Value
( 3,798)
4,276 14,064 14,662
Profitability index
98%
101% 106% 105%
Internal rate of return 11%
13%
14%
15%
Which project (s) should Capital Investment Inc. undertake during the upcoming year if it has only
P600,000 of funds available?
Projects 1 and 3. Projects 2, 3 and 4 Projects 2 and 3 Projects 3 and 4
Ans.
Projects 3 and 4
MS Trucking is considering the purchase of a new piece equipment that has a net initial investment with
a present value of $300,000. The equipment has an estimated useful life of 3 years. For tax purposes, the
equipment will be fully depreciated at rates of 30%, 40%, and 30% in years one, two, and three,
respectively. The new machine is expected to have a $20,000 salvage value. The machine is expected to
save the company $170,000 per year in operating expenses. MS Trucking has a 40% marginal income tax
rate and a 16% cost of capital. Discount rates for a 16% rate are:
Present Value of an
Ordinary Annuity of $1 Present Value of $1
Year 1 .862
.862
Year 2 1.605 .743
Year 3 2.246 .641
What is the net present value of this project?
$31,684 $26,556 $94,640 $18,864
Ans.
$26,556
The technique that reflects the time value of money and is calculated by dividing the present value of
the future net after-tax cash inflows that have been discounted at the desired cost of capital by the initial
cash outlay for an investment is the
Net present value method.
Capital rationing method.
Accounting rate of return method.
Profitability index method.
Ans.
Profitability index method.
CIA 0597 IV-41
A firm with an 18% cost of capital is considering the following projects (on January 1, year 1):
January 1,
Year 1 December 31,Year 5
Cash Outflow (000's Omitted)
Project A
$3,500 $7,400 16%
Project B
4,000 9,950 ?
N
4
5
Cash Inflow (000's Omitted)
Present Value of $1 Due at the End of "N" Periods
12%
14%
15%
16%
18%
20%
22%
.6355 .5921 .5718 .5523 .5158 .4823 .4230
.5674 .5194 .4972 .4761 .4371 .4019 .3411
Project Internal Rate of Return
6
.5066 .4556 .4323 .4104 .3704 .3349 .2751
Project B's internal rate of return is closest to
15% 16% 18% 20%
Ans.
20%
Capital Investment Inc. uses a 12% hurdle rate for all capital expenditures and has done the following
analysis for four project for the upcoming year:
Project1
Project2
Project3
Project4
Initial capital outlay
P200,000
P248,000
P248,000
P272,000
Annual net cash inflows
Year 1 65,000 100,000
80,000 95,000
Year 2 70,000 135,000
95,000 125,000
Year 3 80,000 90,000 90,000 90,000
Year 4 40,000 65,000 80,000 60,000
Net present Value
( 3,798)
4,276 14,064 14,662
Profitability index
98%
101% 106% 105%
Internal rate of return 11%
13%
14%
15%
Which project (s) should Capital Investment Inc. undertake during the upcoming year assuming it has no
budget restrictions?
All of the projects.
Project 1,2, and 3.
Projects 2, 3 and 4.
Projects 1, 3 and 4
Ans.
Projects 2, 3 and 4.
Sensitivity analysis, if used with capital projects,
Is used extensively when cash flows are known with certainly.
Measures the change in the discounted cash flows when using the discounted payback method rather
than the net present value method.
Is a “what-if” technique that asks how a given outcome will change if the original estimates of the
capital budgeting model are changed.
Is a technique used to rank capital expenditure requests.
Ans.
Is a “what-if” technique that asks how a given outcome will change if the original estimates of the capital
budgeting model are changed.
A company purchased a new machine to stamp the company logo on its products. The cost of the
machine was P250,000, and it has an estimated useful life of 5 years with an expected residual value at
the end of its useful life of P50,000. The company uses the straight-line depreciation method.
The machine is expected to save P125,000 annually in operating costs. The company’s tax rate is 40%,
and it uses a 10% discount rate to evaluate capital expenditures.
Year
Present value of P1
Present Value of an Ordinary Annuity of P1
1
.909
.909
2
.826
1.735
3
.751
2.486
4
.683
3.169
5
.621
3.790
What is the net present value (NPV) of the new stamping machine?
P125,940 P200,000 P250,000 P375,940
Ans.
P125,940
CMA 0696 4-24
Jorelle Company's financial staff has been requested to review a proposed investment in new capital
equipment. Applicable financial data is presented below. There will be no salvage value at the end of the
investment's life and, due
to realistic depreciation practices, it is estimated that the salvage value and net book value are equal at
the end of
each year. All cash flows are assumed to take place at the end of each year. For investment proposals,
Jorelle uses a 12% after-tax target rate of return.
Discounted Factors for a 12% Rate of Return
Present Value of an
Present Value of $1.00 Annuity of $1.00
Received at the End
Received at the
Year
of Each Period End of Each Period
1
.89
.89
2
.80
1.69
3
.71
2.40
4
.64
3.04
5
.57
3.61
6
.51
4.12
The net present value for the investment proposal is
$106,160 $(97,970) $356,160 $96,560
Ans.
$106,160
Telephone Corporation is contemplating four projects: L, M, N, and O. The capital cost for the initiation
of each mutually exclusive project and its estimated after-tax, net cash flow are listed below. The
company’s desired after-tax opportunity costs is 12%. It has P900,000 capital budget for the year. Idle
funds cannot reinvest at greater than 12%.
In thousand Pesos
L
M
N
O
470
380
400
420
Annual cash flows
Year 1 113
180
90
80
Year 2 113
170
110
100
Year 3 113
150
130
120
Year 4 113
110
140
130
L
M
N
O
Net present value
P7,540 P59,654
P54,666
P(15,708)
Internal rate of return 12.7% 17.6% 17.2% 10.6%
Excess present value index
1.02
1.13
1.14
0.96
The company will choose
Projects M, N, and O. Projects M and N Projects L and N. Projects L and M
Ans.
Projects M and N
Smoot Automotive has implemented a new project that has an initial cost, and then generates inflows of
$10,000 a year for the next seven (7) years. The project has a payback period of 4.0 years. What is the
project's internal rate of return (IRR)?
14.79% 16.33% 18.54% 15.61%
Ans.
16.33%
The technique that incorporates the time value of money by determining the compound interest rate of
an investment such that the present value of the after-tax cash inflows over the life of the investment is
equal to the initial investment is called the
Internal rate of return method.
Capital asset pricing model.
Profitability index method.
Accounting rate of return method.
Ans.
Internal rate of return method.
At the beginning of 2018, Garrison Corporation is considering the replacement of an old machine that is
currently being used. The old machine is fully depreciated but can be used by the corporation for an
additional 5 years, that is, through 2022. If Garrison decides to replace the old machine, Picco Company
has offered to purchase it for P60,000 on the replacement date. The old machine would have no residual
value in 2022.
If the replacement occurs, a new machine will be acquired from Hillcrest Industries on January 2, 2018.
The purchase price of P1 million for the new machine will be paid in cash at the time of replacement.
Because of the increased efficiency of the new machine, estimated annual cash savings of P300,000 will
be generated through 2022, the end of its expected useful life. The new machine is not expected to have
any residual value at the end of 2022. All operating cash receipts, operating cash expenditures, and
applicable tax payments and credits are assumed to occur at the end of the year. Garrison employs the
calendar year for reporting purposes.
Discount tables for several different interest rates that are to be used in any discounting calculations are
given below.
Present value of P1.00 Received at End of Period
Periods 9%
12%
15%
18%
21%
1
.92
.89
.87
.85
.83
2
.84
.80
.76
.72
.68
3
.77
.71
.65
.61
.56
4
.71
.64
.57
.51
.47
5
.65
.57
.50
.44
.39
Present Value of an Annuity of P1.00
Received at the End of Each Period
Periods 9%
12%
15%
18%
21%
1
.92
.89
.87
.85
.83
2
1.76
1.69
1.63
1.57
1.51
3
2.53
2.40
2.28
2.18
2.07
4
3.24
3.04
2.85
2.69
2.54
5
3.89
3.61
3.35
3.13
2.93
The assumptions are
•
Garrison requires all investments to earn a 12% after-tax of return to be accepted.
•
Garrison is subject to a marginal income tax rate of 40% on all income and gains (losses).
•
The new machine will have depreciation as follows:
Year
Depreciation
2018
P 250,000
2019
380,000
2020
370,000
P 1,000,000
The present value of the depreciation tax shield for 2015 is
P182,400 P121,600 P109,440 P114,304
Ans.
P121,600
Maloney Company uses a 12% hurdle rate for all capital expenditures and has done the following
analysis for four projects for the upcoming year:
Project 1
Project 2
Project 3
Project 4
Initial outlay
$4,960,000
$5,440,000
$4,000,000
$5,960,000
Annual net cash inflows
Year 1 1,600,000
1,900,000
1,300,000
2,000,000
Year 2 1,900,000
2,500,000
1,400,000
2,700,000
Year 3 1,800,000
1,800,000
1,600,000
1,800,000
Year 4 1,600,000
1,200,000
800,000
1,300,000
Net present value
281,280
293,240
(75,960)
85,520
Profitability Index
106% 105% 98%
101%
Internal rate of return 14%
15%
11%
13%
Which projects should Maloney undertake during the upcoming year if it has only $12,000,000 of
investment funds available?
Projects 1 and 3. Projects 1, 2, and 4 Projects 1 and 4 Projects 1 and 2
Ans.
Projects 1 and 2
CMA 1292 4-16
When using the net present value method for capital budgeting analysis, the required rate of return is
called all of the following except the
Risk-free rate. Cost of capital Discount rate Cutoff rate
Ans.
Risk-free rate.
An organization has four investments proposals with the following costs and expected cash inflows:
Expected cash Inflows
End of End of End of
Project Cost Year 1 Year 2 Year 3
A
Unknown
P10,000
P10,000
P10,000
B
P20,000
P 5,000P10,000
P15,000
C
P25,000
P15,000
P10,000
P 5,000
D
P30,000
P20,000
Unknown
P20,000
Additional Information
Discount Rate Number of Periods
Present Value of P1 Due at the End of n Periods (PVF) Present
Value of an Annuity of P1 Due at the End of n Periods (PVFA)
5%
1
0.9524 0.9524
5%
2
0.9070 1.8594
5%
3
0.8638 2.7232
10%
0.9091 0.9091
10%
2
0.8264 1.7355
10%
3
0.7513 2.4869
15%
15%
15%
1
2
3
0.8696 0.8696
0.7561 1.6257
0.6575 2.2832
if the discount rate is 10%, the net present value (NPV) of Project B is
P 4,079 P 6,789 P 9,869 P39,204
Ans.
P 4,079
Which of the following is a limitation of the profitability index?
It uses free cash flows.
It ignores the time value of money.
It is inconsistent with the goal of shareholder wealth maximization.
It requires detailed long-term forecasts of the project's cash flows.
Ans.
It requires detailed long-term forecasts of the project's cash flows.
A company that annually reviews its investment opportunities and selects appropriate capital
expenditures for the coming year is presented with two projects, called Project A and Project B. Best
estimates indicate that the investment outlay for Project A is P30,000 and for Project B is P1 million. The
projects are considered to be equally risky. Project A is expected to generate cash inflows of P40,000 at
the end of the first 2 years. Project B is expected to generate cash inflows of P700,000 at the end of the
first year and P500,000 at the end of the second year. The company has a cost of capital of 8%. In order
to increase production capacity, Rovic Industries is considering replacing an existing production machine
with a new technologically improved machine effective January 1, 2014. The following information is
being considered by Gunning Industries:
·
The new machine would be purchased for P160,000 in cash. Shipping and installation would cost
an additional P30,000.
·
The new machine is expected to increase annual sales by 20,000 units at a sales price of P40 per
unit. Incremental operating costs include P30 per unit in variable cost and total fixed costs of P40,000
per year.
·
The investments in the new machine will require an immediate increase in working capital of
P35,000. This cash outflow will be recovered at the end of year 5.
·
Rovic uses straight-line depreciation for financial reporting and tax reporting purposes. The new
machine has an estimated useful life of five years and zero residual value.
·
Rovic is subject to a 40% corporate income tax rate.
Rovic uses the net present value method to analyze investments and will employ the following factors
and rates:
Present Value of an Ordinary
Period Present Value of P1 at 10%
Annuity of P1 at 10%
1
.909
909
2
.826
1.736
3
.751
2.487
4
.683
3.170
5
.621
3.791
What is the net present value (NPV) of each project when the cost of capital is zero?
Project A
Project B
P 30,000
P1,000,000
P 50,000
P 200,000
P 80,000
P1,200,000
P110,000
P2,200,000
Ans.
P 50,000
P 200,000
CMA 1295 4-14
The net present value of a proposed investment is negative; therefore, the discount rate used must be
Greater than the project's internal rate of return.
Less than the project's internal rate of return.
Greater than the firm's cost of equity.
Less than the risk-free rate.
Ans.
Greater than the project's internal rate of return.
Which of the following decision-making models equates the initial investment with the present value of
the future cash inflows?
Accounting rate of return.
Payback period.
Internal rate of return.
Cost-benefit ratio.
Ans.
Internal rate of return.
Tam Co. is negotiating for the purchase of equipment that would cost P100,000, with the expectation
that P20,000 per year could be saved in after-tax cash costs if the equipment is acquired.The
equipment's estimated useful life is 10 years, with no residual value, and would be depreciated by the
straight-line method. Tam's predetermined minimum desired rate of return is 12%. Present value of an
annuity of 1 at 12% for 10 periods is 5.65. Present value of 1 due in 10 periods at 12% is .322.
Net present value is?
P5,760 P6,440 P12,200 P13,000
Ans.
P13,000
CMA 1293 4-11
If an investment project has a profitability index of 1.15, the
Project's internal rate of return is 15%.
Project's cost of capital is greater than its internal rate of return.
Project's internal rate of return exceeds its net present value.
Net present value of the project is positive.
Ans.
Net present value of the project is positive.
CMA 1294 4-26
The technique used to evaluate all possible capital project of different dollar amounts and then rank
them according to their desirability is the Profitability index method.
Net present value method.
Payback method.
Discounted cash flow method.
Ans.
Profitability index method.
The profitability index approach to investment analysis
Considers only the project’s contribution to profit and does not consider cash flow effect.
Always yield the same accept/ reject decision for mutually-exclusive project as the net present value
method.
Always yield the same accept/reject decision for independent project as the net present value method.
Always yield the same accept/reject decisions for dependent project on the net present value method.
Ans.
Always yield the same accept/reject decision for independent project as the net present value method.
Which one of the following represents the formula used to calculate the profitability index for ranking
projects?
Project cash flow divided by Project cost
Project cost divided by Project cash flow
Project net present value divided by Project cost
Project cost divided by Project net present value
Ans.
Project net present value divided by Project cost
CMA 1293 4-12
The internal rate of return for a project can be determined
If the internal rate of return is greater than the firm's cost of capital.
Only if the project cash flows are constant.
By finding the discount rate that yields a net present value of zero for the project.
By subtracting the firm's cost of capital from the project's profitability index.
Ans.
By finding the discount rate that yields a net present value of zero for the project.
The technique that recognizes the time value of money by discounting the after-tax cash flows for a
project over its life to time period zero using the company's minimum desired rate of return is called
the?
Net present value method
Payback method.
Average rate of return method.
Accounting rate of return method.
Ans.
Net present value method
Capital Invest Inc. uses a 12% hurdle rate for all capital expenditures and has done the following analysis
for four projects for the upcoming year.
Project 1
Project 2
Project 3
Project 4
Initial capital outlay
$200,000
$298,000
$248,000
$272,000
Annual net cash inflows
Year 1 $ 65,000
$100,000
$ 80,000
$ 95,000
Year 2 70,000 135,000
95,000 125,000
Year 3 80,000 90,000 90,000 90,000
Year 4 40,000 65,000 80,000 60,000
Net present value
(3,798) 4,276 14,064 14,662
Profitability Index
98%
101% 106% 105%
Internal rate of return 11%
13%
14%
15%
Which project(s) should Capital Invest Inc. undertake during the upcoming year assuming it has no
budget restrictions?
All of the projects.
Projects 1, 2, and 3
Projects 2, 3, and 4
Projects 1, 3, and 4
Ans.
Projects 2, 3, and 4
Tonya Inc. has a cost of capital of 15% and is considering the acquisition of a new machine that costs
$800,000 and has a useful life of 5 years. Tonya projects that earnings and cash flow will increase as
follows:
Year
Net Earnings After-Tax Cash Flow
1
$200,000
$320,000
2
200,000
280,000
3
200,000
200,000
4
200,000
200,000
5
200,000
200,000
Interest rate factors at 15% are as follows:
Period Present Value of $1
Present Value of an Annuity
1
.87
0.87
2
.76
1.63
3
.66
2.29
4
.57
2.86
5
.50
3.36
The net present value of this investment is?
$(128,000) $200,000 $37,200 $400,000
Ans.
$37,200
A capital budgeting decision model has provided the following information:
Proposal A
Proposal B
Investment
P1,000,000
Investment
P1,800,000
Profitability index
1.2
Profitability index
2.1
Net present value
600,000
Net present value
The better project is
P 300,000
Proposal A because it has the higher net present value.
Proposal B because it has the higher profitability index.
Proposal B because its profitability index is over 2.0.
Proposal A because it has the higher net present value even though its investment base is smaller.
Ans.
Proposal B because it has the higher profitability index.
When determining net present value in an inflationary environment, adjustments should be made to
Increase the discount rate only.
Increase the estimated cash inflows and increase the discount rate.
Decrease the estimated cash inflows and increase the discount rate.
Increase the estimated cash inflows and decrease the discount rate.
Ans.
Increase the estimated cash inflows and increase the discount rate.
Computechs is an all-equity firm that is analyzing a potential mass communications project which will
require an initial, after-tax cash outlay of $100,000, and will produce after-tax cash inflows of $12,000
per year for 10 years. In addition, this project will have an after-tax salvage value of $20,000 at the end
of Year 10. If the risk-free rate is 5 percent, the return on an average stock is 10 percent, and the beta of
this project is 1.80, then what is the project's NPV?
$10,655 $3,234 -$37,407 -$32,012
Ans.
-$32,012
The Apex Company is evaluating a capital budgeting proposal for the current year. The relevant data
follow:
Present value of an Annuity of P1
Year
in Arrears at 15%
1
P0.870
2
1.626
3
2.284
4
2.856
5
3.353
6
3.785
The initial quipment investment would be P30,000. Apex would depreciate the equipment for tax
purposes on a straight-line basis over six years with a zero terminal disposal price. The before-tax annual
cash inflow arising from this investment is P10,000. The income tax rate is 40%, and income tax is paid
the same year as incurred. The after-tax required rate of return is 15%.
What is the net present value of Apex’s capital budgeting proposal?
P(7,290) P
Ans.
P 280
280 P 7,850 P11,760
Universal Corporation is reviewing a capital budgeting decision regarding the acquisition of capital
equipment. Below is the relevant information:
Investment
P300,000
PV of net cash inflows 200,000
Cash-flow tax shield from depreciation 100,000
The company is used to have as benchmark for similar projects at an excess present value index of 0.50,
that is, the project’s index should be no less than 0.50. Should this project be pursued?
No, since the excess present value index is 0.33.
Yes, since the excess present value index is 0.67.
No, since the excess present value index is less than 0.50.
Yes, since the excess present value index is 1.50
Ans.
No, since the excess present value index is less than 0.50.
CMA 1294 4-21
In evaluating a capital budget project, the use of the net present value (NPV) model is generally not
affected by the
Method of funding the project.
Initial cost of the project.
Amount of added working capital needed for operations during the term of the project.
Project's salvage value.
Ans.
Method of funding the project.
CMA 0695 4-8
Capital Invest Inc. uses a 12% hurdle rate for all capital expenditures and has done the following analysis
for four projects for the upcoming year.
Project 1
Project 2
Initial capital outlay
$200,000
Annual net cash inflows
Year 1 $ 65,000
$100,000
Year 2 70,000 135,000
95,000
Year 3 80,000 90,000 90,000 90,000
Year 4 40,000 65,000 80,000 60,000
Net present value
(3,798) 4,276
Profitability Index
98%
101%
Internal rate of return 11%
13%
Project 3
$298,000
Project 4
$248,000
$ 80,000
125,000
$ 95,000
$272,000
14,064 14,662
106% 105%
14%
15%
Which project(s) should Capital Invest Inc. undertake during the upcoming year if it has only $600,000 of
funds available?
Projects 1 and 3. Projects 2, 3, and 4 Projects 2 and 3 Projects 3 and 4.
Ans.
Projects 3 and 4.
What is the approximate IRR for a project that costs $50,000 and provides cash inflows of $20,000 for 3
years?
10% 12% 22% 27%
Ans.
10%
CMA 1291 4-8
Mercken Industries is contemplating four projects, Project P, Project Q, Project R, and Project S. The
capital costs and estimated after-tax net cash flows of each mutually exclusive project are listed below.
Mercken's desired after-tax opportunity cost is 12%, and the company has a capital budget for the year
of $450,000. Idle funds cannot be reinvested at greater than 12%.
Project P
Project Q
Project R
Project S
Initial cost
$200,000
$235,000
$190,000
$210,000
Annual cash flows
Year 1 $93,000
$90,000
$45,000
$40,000
Year 2 93,000 85,000 55,000 50,000
Year 3 93,000 75,000 65,000 60,000
Year 4 -055,000 70,000 65,000
Year 5 -050,000 75,000 75,000
Net present value
$23,370
$29,827
$27,333
$(7,854)
Internal rate of return 18.7% 17.6% 17.2% 10.6%
Excess present value index
1.12
1.13
1.14
0.96
During this year, Mercken will choose
Projects P, Q, and R.
Projects P, Q, R, and S.
Projects Q and R.
Projects P and Q
Ans.
Projects Q and R.
The following data relate to two capital budgeting projects of equal risk:
Present Value of Cash Flows
Period Project A
Project B
0
P(10,000)
P(30,000)
1
4,550 13,650
2
4,150 12,450
3
3,750 11,250
Which of the projects will be selected using the profitability-index (PI) approach and the NPV approach?
PI
B
Either
NPV
A
B
Either
B
Ans.
Either
A
B
B
CMA Samp Q4-4
Jackson Corporation uses net present value techniques in evaluating its capital investment projects. The
company is considering a new equipment acquisition that will cost $100,000, fully installed, and have a
zero salvage value at the end of its five-year productive life. Jackson will depreciate the equipment on a
straight-line basis for both financial and tax purposes. Jackson estimates $70,000 in annual recurring
operating cash income and $20,000 in annual recurring operating cash expenses. Jackson's cost of capital
is 12% and its effective income tax rate is 40%. What is the net present value of this investment on an
after-tax basis?
$28,840 $8,150 $36,990 $80,250
Ans.
$36,990
A company’s marginal cost of new capital (MCC) is 10% up to P600,000. MCC increases by 0.5% for the
next P400,000 and another 0.5% thereafter. Several proposed capital projects are under consideration,
with projected cost and internal rates of return (IRR) as follows:
Project
Cost IRR
A
P100,000
10.5%
B
300.000
14.0
C
450.000
10.8
D
350,000
13.5
E
400,000
12.0
What should the company’s capital budget be?
P
0 P1,050,000 P1,500,000 P1,600,000
Ans.
P1,050,000
The calculation of depreciation is used in the determination of the net present value of an investment for
which of the following reasons,
The decline in the value of the investment should be reflected in the determination o' net present value.
Depreciation adjusts the book value of the investment.
Depreciation represent cash outflow that must be added back to net income.
Depreciation increases cash flow by reducing income taxes.
Ans.
Depreciation increases cash flow by reducing income taxes.
Dr. G invested $10,000 in a lifetime annuity for his granddaughter Emily. The annuity is expected to yield
$400 annually forever. What is the anticipated internal rate of return for the annuity?
Cannot be determined without additional information 4.0% 2.5% 8.0%
Ans.
4.0%
The discount rate ordinarily used in present value calculations is the
Federal Reserve rate.
Treasury bill rate.
Minimum desired rate of return set by the firm.
Prime rate.
Ans.
Minimum desired rate of return set by the firm.
What is the effect of changes in cash flows, investment cost and cash outflows on profitability (present
value) index (PI)
PI will increase with an increase in cash flows, a decrease in investment costs, or a decrease in cash
outflows.
PI will increase with an increase in cash inflows, an increase in investment cost, or an increase in cash
outflows.
PI will decrease with an increase in cash flows, a decrease in investment cost, or a decrease in cash
outflows.
PI will decrease with an increase in cash outflows, an increase in investment cost, or an increase in cash
inflows.
Ans.
PI will increase with an increase in cash flows, a decrease in investment costs, or a decrease in cash
outflows.
Tonya Inc. has a cost of capital of 15% and is considering the acquisition of a new machine that costs
$800,000 and has a useful life of 5 years. Tonya projects that earnings and cash flow will increase as
follows:
Year
Net Earnings After-Tax Cash Flow
1
$200,000
$320,000
2
200,000
280,000
3
200,000
200,000
4
200,000
200,000
5
200,000
200,000
Interest rate factors at 15% are as follows:
Period Present Value of $1
Present Value of an Annuity
1
.87
0.87
2
.76
1.63
3
.66
2.29
4
.57
2.86
5
.50
3.36
What is the profitability index for the investment?
0.05 0.96 1.05 1.25
Ans.
1.05
At the beginning of 2018, Garrison Corporation is considering the replacement of an old machine that is
currently being used. The old machine is fully depreciated but can be used by the corporation for an
additional 5 years, that is, through 2022. If Garrison decides to replace the old machine, Picco Company
has offered to purchase it for P60,000 on the replacement date. The old machine would have no residual
value in 2022.
If the replacement occurs, a new machine will be acquired from Hillcrest Industries on January 2, 2018.
The purchase price of P1 million for the new machine will be paid in cash at the time of replacement.
Because of the increased efficiency of the new machine, estimated annual cash savings of P300,000 will
be generated through 2022, the end of its expected useful life. The new machine is not expected to have
any residual value at the end of 2022. All operating cash receipts, operating cash expenditures, and
applicable tax payments and credits are assumed to occur at the end of the year. Garrison employs the
calendar year for reporting purposes.
Discount tables for several different interest rates that are to be used in any discounting calculations are
given below.
Present value of P1.00 Received at End of Period
Periods 9%
12%
15%
18%
21%
1
.92
.89
.87
.85
.83
2
.84
.80
.76
.72
.68
3
.77
.71
.65
.61
.56
4
.71
.64
.57
.51
.47
5
.65
.57
.50
.44
.39
Present Value of an Annuity of P1.00
Received at the End of Each Period
Periods 9%
12%
15%
18%
21%
1
.92
.89
.87
.85
.83
2
1.76
1.69
1.63
1.57
1.51
3
2.53
2.40
2.28
2.18
2.07
4
3.24
3.04
2.85
2.69
2.54
5
3.89
3.61
3.35
3.13
2.93
The IRR, to the nearest percent, to replace the old machine is?
9%
15% 17% 18%
Ans.
18%
The recommended technique for evaluating projects when capital is rationed and there are no mutually
exclusive projects from which to choose is to rank the projects by.
Accounting rate of return.
Payback.
Internal rate of return.
Profitability index.
Ans.
Profitability index.
Which of the following methods should be used if capital rationing needs to be considered when
comparing capital projects?
Net present value.
Internal rate of return.
Return on investment.
Profitability index.
Ans.
Profitability index.
Everything else being equal, the internal rate of return (IRR) of an investment project will be lower if
The investment cost is lower.
Cash inflows are received later in the life of the project.
Cash inflows are larger.
The project has a shorter payback period.
Ans.
Cash inflows are received later in the life of the project.
Which one of the following is the capital budgeting evaluation approach that determines the number of
periods required for the discounted cash inflows of a project to equal the discounted cash outflows?
Payback period approach.
Discounted payback period approach
Discounted return approach.
Net present value approach.
Ans.
Discounted payback period approach
Risk to a company is affected by both project variability and how project returns correlate with those of
the company’s prevailing business. Overall company risk will be lowest when a project’s returns exhibit
Low variability and negative correlation.
Low variability and positive correlation.
High variability and positive correlation.
High variability and no correlation.
Ans.
Low variability and negative correlation.
A company is considering two projects, which have the following details:
Project A
Project B
Expected sales P1,000 P1,500
Cash operating expense 400
700
Depreciation 150
Tax rate 30%
30%
Which project would provide the largest after¬ tax cash inflow?
Project A because after-tax cash inflow equals P465.
Project A because after-tax cash inflow equals P315.
Project B because after-tax cash inflow equals P635.
Project B because after-tax cash inflow equals P385.
Ans.
Project B because after-tax cash inflow equals P635.
Which of the following statements is most likely correct for a project costing $50,000 and returning
$14,000 per year for 5 years?
NPV = $36,274. NPV = $20,000. IRR = 1.4%. IRR is greater than 10%.
Ans.
IRR is greater than 10%.
A corporation is considering purchasing a machine that costs P100,000 and has a P20,000 salvage value.
The machine will provide net annual cash inflows of P25,000 per year and has a six-year life. The
corporation uses a discount rate of 10%.The discount factor for the present value of a single sum six
years in the future is 0.564. The discount factor for the present value of an annuity for six years is 4.355.
What is the net present value of the machine?
(P2,405) P8,875 P20,155 P28,875
Ans.
P20,155
Pena Company is considering a project that calls for an initial cash outlay of $50,000. The expected net
cash inflows from the project are $7,791 for each of 10 years. What is the IRR of the project?
6% 7% 8% 9%
Ans.
9%
Maloney Company uses a 12% hurdle rate for all capital expenditures and has done the following
analysis for four projects for the upcoming year:
Project 1
Project 2
Project 3
Project 4
Initial outlay
$4,960,000
$5,440,000
$4,000,000
$5,960,000
Annual net cash inflows
Year 1 1,600,000
1,900,000
1,300,000
2,000,000
Year 2 1,900,000
2,500,000
1,400,000
2,700,000
Year 3 1,800,000
1,800,000
1,600,000
1,800,000
Year 4 1,600,000
1,200,000
800,000
1,300,000
Net present value
281,280
293,240
(75,960)
85,520
Profitability Index
106% 105% 98%
101%
Internal rate of return 14%
15%
11%
13%
Which project(s) should Maloney undertake during the upcoming year assuming it has no budget
restrictions?
All of the projects.
Projects 1, 2, and 3.
Projects 1, 2, and 4
Projects 1 and 2.
Ans.
Projects 1, 2, and 4
A proposed investment is not expected to have any salvage value at the end of its 5-year life. For present
value purposes, cash flows are assumed to occur at the end of each year. The company uses a 12% aftertax target rate of return.
Purchase Cost Annual Net After
Annual
Year
and Book Value Tax Cash Flows Net Income
0
$500,000
$ 0 $ 0
1
336,000
240,000
70,000
2
200,000
216,000
78,000
3
100,000
192,000
86,000
4
36,000 168,000
94,000
5
0
144,000
102,000
Discount Factors for a 12% Rate of Return
Present Value of $1 at Present Value of an Annuity of
Year
the End of Each Period $1 at the End of Each Period
1
.89
.89
2
.80
1.69
3
.71
2.40
4
.64
3.04
5
.57
3.61
6
.51
4.12
The net present value is
$304,060 $212,320 $212,320 $712,320
Ans.
$212,320
Universal Corporation is reviewing a capital budgeting decision regarding the acquisition of a capital
equipment. Below is the relevant information:
Investment
P300,000
Excess PV of net cash inflows
200,000
Cash-flow tax shield from depreciation 100,000
The company is used to have as benchmark for similar projects an excess present value index of 0.50,
that is, the project’s index should be no less than 0.50. Should this project be pursued?
No, since the excess present value index is 0.33.
Yes, since the excess present value index is 0.67.
No, since the excess present value index is less than 0.50.
Yes, since the excess present value index is 1.50.
Ans.
Yes, since the excess present value index is 0.67.
Which of the following characteristics represent an advantage of the internal rate of return technique
over the accounting rate of return technique in evaluating a project?
I.
II.
III.
Recognition of the project’s residual value.
Emphasis on cash flows.
Recognition of the time value of money.
I only I and II. II and III I, II and III
Ans.
II and III
When the risks of the individual components of a project’s cash flows are different, an acceptable
procedure to evaluate these cash flows is to
Divide each cash flows by the payback period.
Compute the net present value of each cash flow using firm’s cost of capital.
Compare the internal rate of return from each cash flow to its risk.
Discount each cash flow using a discount rate that reflects the degree of risk.
Ans
Discount each cash flow using a discount rate that reflects the degree of risk.
CMA 1291 4-9
Mercken Industries is contemplating four projects, Project P, Project Q, Project R, and Project S. The
capital costs and estimated after-tax net cash flows of each mutually exclusive project are listed below.
Mercken's desired after-tax opportunity cost is 12%, and the company has a capital budget for the year
of $450,000. Idle funds cannot be reinvested at greater than 12%.
Project P
Project Q
Project R
Project S
Initial cost
$200,000
$235,000
$190,000
$210,000
Annual cash flows
Year 1 $93,000
$90,000
$45,000
$40,000
Year 2 93,000 85,000 55,000 50,000
Year 3 93,000 75,000 65,000 60,000
Year 4 -055,000 70,000 65,000
Year 5 -050,000 75,000 75,000
Net present value
$23,370
$29,827
$27,333
$(7,854)
Internal rate of return 18.7% 17.6% 17.2% 10.6%
Excess present value index
1.12
1.13
1.14
0.96
If Mercken is able to accept only one project, the company would choose?
Project P.
Project Q because it has the highest net present value.
Project P because it has the highest internal rate of return.
Project P because it has the shortest payback period.
Ans.
Project Q because it has the highest net present value.
Which of the following statements is false?
The net present value (NPV) of a project with cash flows that comes in relatively slowly is more sensitive
to changes in the discount rate than is the NPV of a project with cash flows that come in rapidly.
Other things held constant, a decrease in the cost of capital (discount rate) will cause an increase in a
project’s internal rate of return (IRR).
The IRR method can be used in place of the NPV method for all independent projects because the two
methods then result in identical decisions.
The NPV method is preferred over the IRR method because the NPV method’s reinvestment rate
assumption is the correct assumption.
Ans.
Other things held constant, a decrease in the cost of capital (discount rate) will cause an increase in a
project’s internal rate of return (IRR).
You are engaged by the Brod Company to evaluate the introduction of a new product line with an
innovative packaging. You computed the net present value (NPV) and internal rate or return (IRR). If your
client would reduce the estimate for its sales of the new product and increase the projected cost of
capital, what would be the impact of these revisions in the estimates on NPV and IRR?
NPV will increase, IRR will increase.
NPV will decrease, IRR will increase.
NPV will increase, IRR will decrease.
NPV will decrease, IRR will decrease.
Ans.
NPV will decrease, IRR will decrease.
Polo Company requires higher rate of return for projects with a life span greater than 5 year. Projects
extending beyond 5 years must earn a higher specified rate of return. Which of the following capital
budgeting techniques can readily accommodate this requirement?
Internal rate of return
Yes
No
No
Yes
No
No
Yes
Ans.
No
Yes
Net present value
Yes
The net present value (NPV) method and the internal rate of return (IRR) method are used to analyze
capital expenditures. The IRR method, as contrasted with the NPV method
Is considered inferior because it fails to calculate compounded interest rates.
Incorporates the time value of money whereas the NPV method does not.
Assumes that the rate of return on the reinvestment of the cash proceeds is at the indicated rate of
return of the project analyzed rather than at the discount rate used.
Is preferred in practice because it is able to handle multiple desired hurdle rates, which is impossible
with the NPV method.
Ans.
Assumes that the rate of return on the reinvestment of the cash proceeds is at the indicated rate of
return of the project analyzed rather than at the discount rate used.
The internal rate of return on an investment
Usually coincides with the company's hurdle rate.
Disregards discounted cash flows.
May produce different rankings from the net present value method on mutually exclusive projects.
Would tend to be reduced if a company used an accelerated method of depreciation for tax purposes
rather than the straight-line method.
Ans.
May produce different rankings from the net present value method on mutually exclusive projects.
What is the time value of money?
Interest. Present value Future value Annuity
Ans.
Interest.
CMA 0693 4-21
Essex Corporation is evaluating a lease that takes effect on March 1. The company must make eight equal
payments, with the first payment due on March 1. The concept most relevant to the evaluation of the
lease is?
The present value of an annuity due.
The present value of an ordinary annuity.
The future value of an annuity due.
The future value of an ordinary annuity.
Ans.
The present value of an annuity due.
Your real estate agent mentions that homes in your price range require a payment of approximately
$800 per month over 30 years at 10% interest. What is the approximate size of the mortgage with these
terms?
$91,200 $100,300 $259,200 $288,000
Ans.
$91,200
CIA 1192 IV-55
A company plans to purchase a machine with the following conditions:
ｷ Purchase price = $300,000.
ｷ The down payment = 10% of purchase price with remainder financed at an annual interest rate of
16%.
ｷ The financing period is 8 years with equal annual payments made every year.
ｷ The present value of an annuity of $1 per year for 8 years at 16% is 4.3436.
ｷ The present value of $1 due at the end of 8 years at 16% is .3050.
The annual payment (rounded to the nearest dollar) is?
$39,150 $43,200 $62,160 $62,160
Ans.
$62,160
The net present value and internal rate of return methods of capital budgeting are superior to the
payback method in that they: (M)
are easier to implement.
consider the time value of money.
require less input.
reflect the effects of depreciation and income taxes.
Ans.
consider the time value of money.
Which one of the following sets of interest (or discount) rates will give the greater present value of P1.00
and greater future value of P1.00?
Greater
Greater
Present Value Future Value
10%
10%
10%
8%
8%
10%
8%
8%
Ans.
8%
10%
Which of the following statements is correct?
The straight line method of depreciation is better because of its simplicity.
The accelerated method of depreciation would record depreciation expense as much as the straight line
method over the life of the project, however, results to the net present value of tax savings from early
recording of greater depreciation expense.
There is no material financial difference in the use of the straight line and accelerated method of
depreciation.
The accelerated method of depreciation is not allowed for tax purposes.
Ans.
The accelerated method of depreciation would record depreciation expense as much as the straight line
method over the life of the project, however, results to the net present value of tax savings from early
recording of greater depreciation expense.
If the tax law were changed so that owners of apartment buildings had to depreciate them over 50 years
instead of the current 31.5 years
Rents would rise.
Rents would fall because annual depreciation charges would fall.
Rents would stay about the same.
More people would invest in apartment buildings.
Ans.
Rents would rise.
CMA 1295 4-10
Janet Taylor Casual Wear has $75,000 in a bank account as of December 31, 2001. If the company plans
on depositing $4,000 in the account at the end of each of the next 3 years (2002, 2003, and 2004) and all
amounts in the account earn 8% per year, what will the account balance be at December 31, 2004?
Ignore the effect of income taxes.
1
2
3
4
8% Interest Rate Factors
Future Value Future Value of
Period of an Amount of $1
an Ordinary Annuity of $1
1.08
1.00
1.17
2.08
1.26
3.25
1.36
4.51
$87,000 $88,000 $96,070 $107,500
Ans.
$107,500
CMA 1291 4-12
Crown Corporation has agreed to sell some used computer equipment to Bob Parsons, one of the
company's employees, for $5,000. Crown and Parsons have been discussing alternative financing
arrangements for the sale. The information in the opposite column is pertinent to these discussions.
Present Value of an Ordinary Annuity of $1
Payments
5%
6%
7%
8%
1
0.952 0.943 0.935 0.926
2
1.859 1.833 1.808 1.783
3
2.723 2.673 2.624 2.577
4
3.546 3.465 3.387 3.312
5
4.329 4.212 4.100 3.993
6
5.076 4.917 4.767 4.623
7
5.786 5.582 5.389 5.206
8
6.463 6.210 5.971 5.747
If Bob Parsons borrowed the $5,000 at 8% interest for 4 years from his bank and paid Crown Corporation
the full price of the equipment immediately, Crown could invest the $5,000 for 3 years at 7%. The future
value of this investment (rounded) would be
$6,297 $6,127 $6,553 $6,803
Ans.
$6,127
If the amount to deposit today to be able to replace an asset at a specified time in the future is to be
determined, which formula should be used?
(1 + i)・
PV= -------FV
PV = FV x (1 + i)・
FV
PV = ------(1 + i)・
PV
(1 + i)・ = ---FV
General Feedback
FV
PV = ------(1 + i)・
Ans.
FV
PV = ------(1 + i)・
CMA 1291 4-11
Crown Corporation has agreed to sell some used computer equipment to Bob Parsons, one of the
company's employees, for $5,000. Crown and Parsons have been discussing alternative financing
arrangements for the sale. The information in the opposite column is pertinent to these discussions.
Present Value of an Ordinary Annuity of $1
Payments
5%
6%
7%
8%
1
0.952 0.943 0.935 0.926
2
1.859 1.833 1.808 1.783
3
4
5
6
7
8
2.723
3.546
4.329
5.076
5.786
6.463
2.673
3.465
4.212
4.917
5.582
6.210
2.624
3.387
4.100
4.767
5.389
5.971
2.577
3.312
3.993
4.623
5.206
5.747
Bob Parsons has agreed to the immediate down payment of $1,000 but would like the note for $4,000 to
be payable
in full at the end of the fourth year. Because of the increased risk associated with the terms of this note,
Crown Corporation would apply an 8% discount rate. The present value of this note would be
$2,940 $3,312 $3,940 $2,557
Ans.
$2,940
If depreciation of a new asset exceeds its savings in cash operating costs, which of the following is true?
The project is usually unacceptable.
The annual after-tax cash flow on the new asset will be greater than the savings in cash operating costs.
The project has a negative NPV.
All of the above.
Ans.
All of the above.
Which of the following changes would result in the highest present value?
A P100 decrease in taxes each year for four years.
A P100 decrease in the cash outflow each year for three years.
A P100 increase in disposal value at the end of four years.
A P100 increase in cash inflows each year for three years.
Ans.
A P100 decrease in taxes each year for four years.
CIA 1192 IV-39
An actuary has determined that a company should have $90,000,000 accumulated in its pension fund 20
years from now in order for the fund to be able to meet its obligations. An interest rate of 8% is
considered appropriate for all pension fund calculations involving an interest component. The company
wishes to calculate how much it should contribute to the pension fund at the end of each of the next 20
years in order for the pension fund to have its required balance in 20 years. Assume you are given the
following two factors from present value and future value tables:
1) Factor for present value of an ordinary annuity for n=20, i=8%
2) Factor for future value of an ordinary annuity for n=20, i=8%.Which of the following sets of
instructions correctly describes the procedures necessary to compute the annual amount the company
should contribute to the fund?
Divide $90,000,000 by the factor for present value of an ordinary annuity for n=20, i=8%.
Multiply $90,000,000 by the factor for present value of an ordinary annuity for n=20, i=8%.
Divide $90,000,000 by the factor for future value of an ordinary annuity for n=20, i=8%.
Multiply $90,000,000 by the factor for future value of an ordinary annuity for n=20, i=8%.
Ans.
Divide $90,000,000 by the factor for future value of an ordinary annuity for n=20, i=8%.
Assume your uncle recorded his salary history during a 40-year career and found that it had increased
ten-fold. If inflation averaged 5% annually during the period, how would you describe his purchasing
power, on average?
His purchasing power remained on par with inflation.
He "beat" inflation by nearly 1% annually.
He "beat" inflation by slightly over 2% annually.
He "beat" inflation by 5% annually.
Ans.
He "beat" inflation by nearly 1% annually.
CIA 0582 IV-5
(Refers to Fact Pattern #13)
Present value, amount of $1, and ordinary annuity information are presented below. All values are for
four periods with an interest rate of 8%.
Amount of $1 .36
Present value of $1
0.74
Amount of an ordinary annuity of $1
4.51
Present value of an ordinary annuity of $1
3.31
Jones wants to accumulate $50,000 by making equal contributions at the end of each of 4 succeeding
years. Which equation would be used to compute Jones's annual contribution to achieve the $50,000
goal at the end of the fourth year?
$X = $50,000 ・4.51
$X = $50,000 ・4.00
$X = $12,500 ・1.36
$X = $50,000 ・3.31
Ans.
$X = $50,000 ・4.51
CMA 1291 4-10
Crown Corporation has agreed to sell some used computer equipment to Bob Parsons, one of the
company's employees, for $5,000. Crown and Parsons have been discussing alternative financing
arrangements for the sale. The information in the opposite column is pertinent to these discussions.
Present Value of an Ordinary Annuity of $1
Payments
5%
6%
7%
8%
1
0.952 0.943 0.935 0.926
2
1.859 1.833 1.808 1.783
3
2.723 2.673 2.624 2.577
4
3.546 3.465 3.387 3.312
5
4.329 4.212 4.100 3.993
6
5.076 4.917 4.767 4.623
7
5.786 5.582 5.389 5.206
8
6.463 6.210 5.971 5.747
Crown Corporation has offered to accept a $1,000 down payment and set up a note receivable for Bob
Parsons that calls for a $1,000 payment at the end of each of the next 4 years. If Crown uses a 6%
discount rate, the present value of the note receivable would be?
$2,940 $4,465 $4,212 $3,465
Ans.
$3,465
Pole Co. is investing in a machine with a three-year life. The machine is expected to reduce annual cash
operating costs by P30,000 in each of the first two years and by P20,000 in year 3. Present values of an
annuity of P1 at 14% are:
Period
1
0.88
2
1.65
3
2.32
Using a 14% cost of capital, what is the present value of these future savings?
P59,600 P60,800 P62,900 P69,500
Ans.
P62,900
CIA 0592 IV-53
The relationship between the present value of a future sum and the future value of a present sum can be
expressed in terms of their respective interest factors. If the present value of $100,000 due at the end of
8 years, at 10%, is $46,650, what is the approximate future value of $100,000 over the same length of
time and at the same rate?
$46,650 $100,000 $146,650 $214,360
Ans.
$214,360
Future value is best described as?
The sum of dollars-in discounted to time zero.
The sum of dollars-out discounted to time zero.
The value of a dollar-in at a future time adjusted for any compounding effect
The value of a dollar-in at a future time adjusted for any compounding effect and the value of a dollarout at a future time adjusted for any compounding effect.
Ans.
The value of a dollar-in at a future time adjusted for any compounding effect and the value of a dollarout at a future time adjusted for any compounding effect.
How long must one wait (to the nearest year) for an initial investment to triple in value if the investment
earns 9% compounded annually?
13 16 17 22
Ans.
13
Amaro Hospital, a nonprofit institution not subject to income taxes, is considering the purchase of new
equipment costing P20,000, in order to achieve cash savings of P5,000 per year in operating costs. The
equipment’s estimated useful life is ten years, with no residual value. Amaro’s cost of capital is 14%. For
ten periods of 14%, the present value of P1 is 0.270, while the present value of an ordinary annuity of P1
is 5.216.
What factor contained in or developed from the above information should be used in computing the
internal rate of return for Amaro’s proposed investment in the new equipment?
5.216 4.000 1.400 0.270
Ans.
4.000
Which of the following is a series of equal payments at equal intervals of time with each payment made
(received) at the beginning of each time period?
Ordinary annuity. Annuity in arrears Annuity due. Payments in advance
Ans.
Annuity due.
Which of the following “tools” are likely to be used in financial management?
Time Value of Money Interest Rate Concepts Balance of Payment Accounts
Yes
Yes
Yes
Yes
No
No
No
Yes
No
No
Ans.
Yes
No
No
No
No
The U.S. Postal Service is looking for a new machine to help sort the mail. Two companies have
submitted bids to Cliff Kraven, the postal inspector responsible for choosing a machine. A cash flow
analysis of the two machines indicates the following:
Year
0
1
2
3
4
Machine A
Machine B
-$30,000
-$30,000
0
13,000
0
13,000
0
13,000
60,000 13,000
If the cost of capital for the Postal Service is 8%, which of the two mail sorters should Cliff choose and
why?
Machine A, because NPVA > NPVB, by $1,044.
Machine B, because NPVA < NPVB, by $22,000.
Machine A, because NPVA > NPVB, by $8,000.
Machine B, because IRRA < IRRB.
Ans.
Machine A, because NPVA > NPVB, by $1,044.
Essex Corporation is evaluating a lease that takes effect on March 1. The company must make eight equal
payments, with the first payment due on March 1. The concept most relevant to the evaluation of the
lease is
Basic time value of money concepts concern
Interest Factors Risk
Cost of Capital
Yes
Yes
No
Yes
No
Yes
No
Yes
No
No
Ans.
Yes
No
Yes
Yes
No
In the determination of a present value, which of the following relationships is correct?
The lower the discount rate and the shorter the discount period, the lower the present value.
The lower the future cash flow and the shorter the discount period, the lower the present value.
The higher the discount rate and the longer the discount period, the lower the present value.
The higher the future cash flow and the longer the discount period, the lower the present value.
Ans.
The higher the discount rate and the longer the discount period, the lower the present value.
The use of an accelerated method instead of the straight-line method of depreciation in computing the
net present value of a project has the effect of
Raising the hurdle rate necessary to justify the project.
Lowering the net present value of the project.
Increasing the present value of the depreciation tax shield.
Increasing the cash outflows at the initial point of the project.
Ans.
Increasing the present value of the depreciation tax shield.
Use the following 8% interest rate factors for this question.
Period
1
2
3
4
Future Value of
Future Value of $1
Annuity of $1
1.08
1.00
1.17
2.08
1.26
3.25
1.36
4.51
The Suellen Company has $150,000 in a bank account as of December 31, 2001. If the company plans to
deposit $8,000 in the account at the end of each of the next 3 years (2002, 2003, and 2004), and all
amounts in the account earn 8% per year, what will the account balance be at December 31, 2004?
Ignore the effect of income taxes.
$174,000 $176,000 $192,140 $215,000
Ans.
$215,000
Which of the following is a series of equal payments at equal intervals of time when each payment is
received at the beginning of each time period?
Ordinary annuity Annuity in arrears Annuity due Payments in advance
Ans.
Annuity due
What is the yield to maturity on Fox Inc.'s bonds if its after-tax cost of debt is 9% and its tax rate is 34%?
5.94% 9% 13.64% 26.47%
Ans.
13.64%
CIA 0582 IV-6
A loan is to be repaid in eight annual installments of $1,875. The interest rate is 10%. The present value
of an ordinary annuity for eight periods at 10% is 5.33. Identify the computation that approximates the
outstanding loan balance at the end of the first year.
$1,875 x 5.33 = $9,994
$1,875 x 5.33 = $9,994; $9,994 - $1,875 = $8,119
$1,875 x 5.33 = $9,994; $1,875 - $999 = $876; $9,994 - $876 = $9,118
$1,875 x 8 = $15,000; $15,000 - ($1,875 - $1,500) = $14,625
Ans.
$1,875 x 5.33 = $9,994; $1,875 - $999 = $876; $9,994 - $876 = $9,118
An individual received an inheritance from a grandparent’s estate. The money can be invested and the
individual can either (a) receive a P20,000 lump-sum amount at the end of 10 years or (b) receive P1,400
at the end of each year for the next 10 years. The individual wants a rate of return of 12% and uses the
following information:
1. Present value of P1 = 0.322
2. Present value of annuity of P1 = 5.650.
What is the preferred investment option and what is its net present value?
Option b, P451. Option a, P6,440. Option b, P7,910 Option a, P113,000
Ans.
Option b, P7,910
Mr. Al Berbano is contemplating to buy a machine to increase the capacity of his manufacturing
operations. He consults you for advice on the alternatives of leasing or buying the equipment. If
purchased, the straight line depreciation expense will be P18,700 annually over its life of 5 years. The
annual lease payment will amount to P29,000 payable at the end of each of the 5 years. Cost of money is
18%. Tax rate is 35%. There is no residual value. Present value of P1 received annually for 5 years at 18%
is 3.127. Present value of P1 due in 5 years at 18% is .437. What will you recommend and why?
Lease the machine because leasing saves P2,817 per year.
Lease the machine because leasing saves P4,506 per year.
Buy the machine because depreciation saves P16,545 each year.
Lease the machine because outlay is less by P58,944.
Ans.
Lease the machine because leasing saves P4,506 per year.
For the next 2 years, a lease is estimated to have an operating net cash inflow of $7,500 per annum,
before adjusting for $5,000 per annum tax basis lease amortization, and a 40% tax rate. The present
value of an ordinary annuity of $1 per year at 10% for 2 years is 1.74. What is the lease’s after-tax
present value using a 10% discount factor? (E)
$2,610 $4,350 $9,570 $11,310
Ans.
$11,310
Mr. Al Berbano is contemplating to buy a machine to increase the capacity of his manufacturing
operations. He consults you for advice on the alternatives of leasing or buying the equipment. If
purchased, the straight line depreciation expense will be P18,700 annually over its life of 5 years. The
annual lease payment will amount to P29,000 payable at the end of each of the 5 years. Cost of money is
18%. Tax rate is 35%. There is no residual value. Present value of P1 received annually for 5 years at 18%
is 3.127. Present value of P1 due in 5 years at 18% is .437. What will you recommend and why?
Lease the machine because leasing saves P2,817 per year.
Lease the machine because leasing saves P4,506 per year.
Buy the machine because depreciation saves P16,545 each year.
Lease the machine because outlay is less by P58,944.
Ans.
Lease the machine because leasing saves P4,506 per year.
Which of the following items is not considered in the analysis of lease or buy decision in capital
expenditures?
Present value of residual value.
Present value of lease payments.
Purchase price of the asset.
Tax savings from lease payment.
Ans.
Tax savings from lease payment.
Mr. Al Berbano is contemplating to buy a machine to increase the capacity of his manufacturing
operations. He consults you for advice on the alternatives of leasing or buying the equipment. If
purchased, the straight line depreciation expense will be P18,700 annually over its life of 5 years. The
annual lease payment will amount to P29,000 payable at the end of each of the 5 years. Cost of money is
18%. Tax rate is 35%. There is no residual value. Present value of P1 received annually for 5 years at 18%
is 3.127. Present value of P1 due in 5 years at 18% is .437. What will you recommend and why?
Lease the machine because leasing saves P2,817 per year.
Lease the machine because leasing saves P4,506 per year.
Buy the machine because depreciation saves P16,545 each year.
Lease the machine because outlay is less by P58,944.
Ans.
Lease the machine because leasing saves P4,506 per year.
An office equipment representative has a machine for sale or lease. If you buy the machine, the cost is
P7,596. If you lease the machine, you will have to sign a non-cancelable lease and make 5 payments of
P2,000 each. The first payment will be paid on the first day of the lease. At the time of the last payment
you will receive title to the machine. The present value of an ordinary annuity of P1 is as follows:
Number of
Present value
.
Periods
10%
12%
16% .
1
0.909
0.8983
0.862
2
1.736
1.690
1.605
3
2.487
2.402
2.246
4
3.170
3.037
2.798
5
3.791
3.605
3.274
The interest rate implicit in this lease is approximately
10% 12% Between 10% and 12% 16%
Ans.
16%
For the next 2 years, a lease is estimated to have an operating net cash inflow of P7,500 per annum,
before adjusting for P5,000 per annum tax basis lease amortization, and a 40% tax rate. The present
value of an ordinary annuity of P1 per year at 10% for 2 years is 1.74. What is the lease’s after-tax
present value using a 10% discount factor? (E)
P2,610 P4,350 P9,570 P11,310
Ans.
P11,310
A company that annually reviews its investment opportunities and selects appropriate capital
expenditures for the coming year is presented with two projects, called Project A and Project B. Best
estimates indicate that the investment outlay for Project A is P30,000 and for Project B is P1 million. The
projects are considered to be equally risky. Project A is expected to generate cash inflows of P40,000 at
the end of the first 2 years. Project B is expected to generate cash inflows of P700,000 at the end of the
first year and P500,000 at the end of the second year. The company has a cost of capital of 8%.
10% 15% 25% 100%
Ans.
100%
A project requires an initial cash investment at its inception of $10,000, and no other cash outflows are
necessary. Cash inflows from the project over its 3-year life are $6,000 at the end of the first year, $5,000
at the end of the second year, and $2,000 at the end of the third year. The future value interest factors
for an amount of $1 at the cost of capital of 8% are
Period
1
2
3
4
1.080 1.166 1.260 1.360
The present value interest factors for an amount of $1 for
three periods are as follows:
Interest Rate
8%
9%
.794
.772
10%
.751
12%
.712
14%
.675
The modified IRR (MIRR) for the project is closest to
8% 9% 10% 12%
Ans.
12%
CMA 0695 4-2
Sensitivity analysis, if used with capital projects,
Is used extensively when cash flows are known with certainty.
Measures the change in the discounted cash flows when using the discounted payback method rather
than the net present value method.
Is a "what-if" technique that asks how a given outcome will change if the original estimates of the
capital budgeting model are changed.
Is a technique used to rank capital expenditure equests.
Ans.
Is a "what-if" technique that asks how a given outcome will change if the original estimates of the capital
budgeting model are changed.
1.
In order to increase production capacity, Rovic Industries is considering replacing an existing
production machine with a new technologically improved machine effective January 1, 2014. The
following information is being considered by Gunning Industries:
•
The new machine would be purchased for P160,000 in cash. Shipping and installation would cost
an additional P30,000.
•
The new machine is expected to increase annual sales by 20,000 units at a sales price of P40 per
unit. Incremental operating costs include P30 per unit in variable cost and total fixed costs of P40,000
per year.
•
The investments in the new machine will require an immediate increase in working capital of
P35,000. This cash outflow will be recovered at the end of year 5.
•
Rovic uses straight-line depreciation for financial reporting and tax reporting purposes. The new
machine has an estimated useful life of five years and zero residual value.
•
Rovic is subject to a 40% corporate income tax rate.
Rovic uses the net present value method to analyze investments and will employ the following factors
and rates:
Present Value of an Ordinary
Period Present Value of P1 at 10%
Annuity of P1 at 10%
1
909
909
2
826
1.736
3
751
2.487
4
683
3.170
5
621
3.791
The overall discounted cash flow impact of Rovic Industry’s working capital investments for the new
production machine would be
P( 7,959)
P(10,080)
P(13,265)
P(35,000)
Ans.
P(13,265)
CMA 1292 4-15
The rankings of mutually exclusive investments determined using the internal rate of return method
(IRR) and the net
present value method (NPV) may be different when?
The lives of the multiple projects are equal and the size of the required investments are equal.
The required rate of return equals the IRR of each
project.
The required rate of return is higher than the IRR of each project.
Multiple projects have unequal lives and the size of the investment for each project is different.
Ans.
Multiple projects have unequal lives and the size of the investment for each project is different.
Union Electric Company must clean up the water released from its generating plant. The company's cost
of capital is 11 percent for average projects, and that rate is normally adjusted up or down by 2
percentage points for high- and low-risk projects. Clean-Up Plan A, which is of average risk, has an initial
cost of $10 million, and its operating cost will be $1 million per year for its 10-year life. Plan B, which is a
high-risk project, has an initial cost of $5 million, and its annual operating cost over Years 1 to 10 will be
$2 million. What is the approximate PV of costs for the better project?
-$5.9 million $15.9 million -$16.8 million -$17.8 million
Ans.
$15.9 million
Logg Company is planning to buy a coin-operated machine costing P40,000. For tax purposes, this
machine will be depreciated over a five-year period using the straight-line method and no residual value.
Assume that the investment tax credit is not applicable to this purchase. Logg estimates that this
machine will yield an annual cash inflow, net of depreciation and income taxes, of P12,000. At the
following discount rates, the net present values of the investment are:
Discount
Net present
rate
value
12% + P3,258
14% + 1,197
16% 708
18% - 2,474
Logg’s desired rate of return on its investment is 12%.
Logg’s accounting rate of return on its initial investment in this machine is expected to be
30% 15% 12% 10%
Ans.
10%
1.
In order to increase production capacity, Rovic Industries is considering replacing an existing
production machine with a new technologically improved machine effective January 1, 2014. The
following information is being considered by Gunning Industries:
•
The new machine would be purchased for P160,000 in cash. Shipping and installation would cost
an additional P30,000.
•
The new machine is expected to increase annual sales by 20,000 units at a sales price of P40 per
unit. Incremental operating costs include P30 per unit in variable cost and total fixed costs of P40,000
per year.
•
The investments in the new machine will require an immediate increase in working capital of
P35,000. This cash outflow will be recovered at the end of year 5.
•
Rovic uses straight-line depreciation for financial reporting and tax reporting purposes. The new
machine has an estimated useful life of five years and zero residual value.
•
Rovic is subject to a 40% corporate income tax rate.
Rovic uses the net present value method to analyze investments and will employ the following factors
and rates:
Present Value of an Ordinary
Period Present Value of P1 at 10%
Annuity of P1 at 10%
1
909
909
2
826
1.736
3
751
2.487
4
683
3.170
5
621
3.791
The acquisition of new production machine by Rovic Industries will contribute a discounted net-tax
contribution margin of?
P242,624 P303,280 P363,936 P454,920Ans.
Ans.
P454,920
CMA 1293 4-16
Sensitivity analysis is used in capital budgeting to?
Estimate a project's internal rate of return.
Determine the amount that a variable can change without generating unacceptable results
Simulate probabilistic customer reactions to a new product.
Identify the required market share to make a new product viable and produce acceptable results.
Ans.
Determine the amount that a variable can change without generating unacceptable results
CMA 1293 4-17
If income tax considerations are ignored, how is depreciation handled by the following capital budgeting
techniques?
Internal Accounting
Rate of Return Rate of Return Payback
Excluded
Included
Excluded
Included
Excluded
Included
Excluded
Excluded
Included
Included
Ans.
Excluded
Included
Excluded
Included
Included
CMA 0695 4-3
The use of an accelerated method instead of the straight-line method of depreciation in computing the
net present value of a project has the effect of
Raising the hurdle rate necessary to justify the project.
Lowering the net present value of the project.
Increasing the present value of the depreciation tax shield.
Increasing the cash outflows at the initial point of the project.
Ans.
Increasing the present value of the depreciation tax shield.
Which of the following statements is most correct? (M)
The MIRR method will always arrive at the same conclusion as the NPV method.
The MIRR method can overcome the multiple IRR problem, while the NPV method cannot.
The MIRR method uses a more reasonable assumption about reinvestment rates than the IRR method.
Statements a and c are correct.
Ans.
The MIRR method uses a more reasonable assumption about reinvestment rates than the IRR method.
A widely used approach that is used to recognize uncertainty about individual economic variables while
obtaining an immediate financial estimate of the consequences of possible prediction errors is
Expected value analysis.
Learning curve analysis.
Sensitivity analysis
Regression analysis.
Ans.
Sensitivity analysis
On July 1, 2018, James Jacinto signed an agreement to operate a franchise of Fast Foods, Inc., for an
initial franchise fee of P60,000. Of this amount, P20,000 was paid when the agreement was signed and
the balance is payable in four equal annual payments of P10,000 beginning July 1, 2014. The agreement
provides that the down payment is not refundable and no future services are required of the franchisor.
Jacinto’s credit rating indicates that he can borrow money at 14% for a loan of this type. Information on
present and future value factors is as follows:
Present value of P1 at 14% for 4 periods 0.59
Future amount of P1 at 14% for 4 periods
1.69
Present value of an ordinary annuity of P at 14% for 4 periods
2.91
Jacinto should record the acquisition cost of the franchise on July 1, 2018, at
P43,600 P49,100 P60,000 P67,600
Ans.
P49,100
A firm with an 18% cost of capital is considering the following projects (on January 1, 2014):
January 1, 2014 December 31, 2010
Cash Outflow Cash Inflow
Project Internal
(000’s Omitted) (000’s Omitted) Rate of Return
Project A
P 3,500 P 7,400 16%
Project B
4,000 9,950 ?
Present value of P1 Due at the End of “N” Periods
C
4
5
6
12%
14%
15%
16%
18% 20%
22%
.6355 .5921 .5718 .5523 .5158 .482
.4230
.5674 .5194 .4972 .4371 .4371 .4019 .3411
.5066 .4556 .4323 .4101 .3704 .3349 .2751
Using the net-present-value (NPV) method, project A’s net present value is?
P316,920 P 23,140 P(265,460) P(316,920)
Ans.
P(265,460)
Projects A and B have the same expected lives and initial cash outflows. However, one project’s cash
flows are larger in the early years, while the other project has larger cash flows in the later years. The
two NPV profiles are given below:
Which of the following statements is most correct?
Project A has the smaller cash flows in the later years.
Project A has the larger cash flows in the later years.
We require information on the cost of capital in order to determine which project has larger early cash
flows.
The NPV profile graph is inconsistent with the statement made in the problem. Brigham
Ans.
Project A has the larger cash flows in the later years.
When the risks of the individual components of a project's cash flows are different, an acceptable
procedure to evaluate these cash flows is to
Divide each cash flow by the payback period.
Compute the net present value of each cash flow using the firm's cost of capital.
Compare the internal rate of return from each cash flow to its risk.
Discount each cash flow using a discount rate that reflects the degree of risk.
Ans.
Discount each cash flow using a discount rate that reflects the degree of risk.
On January 1, 2014, FD Company issued ten-year bonds with a face value of P1,000,000 and a started
interest rate of 8% per year payable semiannually July 1 and January 1. The bonds were sold to yield
10%. Present value factors are as follows:
Present value of 1 for 10 periods at 10% .386
Present value of 1 for 20 periods at 5%
.377
Present value of an annuity of 1 for 10 periods at 10%
Present value of an annuity of 1 for 20 periods at 5%
The total issue price of the bonds is?
P 875,480 P 877,600 P 980,000 P1,000,000
Ans.
P 875,480
6.145
12.462
Rohan Transport is considering two alternative busses to transport people between cities that are in the
Southeastern U.S., such as Baton Rouge and Gainesville. A gas-powered bus has a cost of $55,000, and
will produce end-of-year net cash flows of $22,000 per year for 4 years. A new electric bus will cost
$90,000, and will produce cash flows of $28,000 per year for 8 years. The company must provide bus
service for 8 years, after which it plans to give up its franchise and to cease operating the route. Inflation
is not expected to affect either costs or revenues during the next 8 years. If Rohan Transport's cost of
capital is 17 percent, by what amount will the better project increase the company's value?
$5,350 -$17,441 $10,701 $27,801
Ans.
$27,801
Mulva Inc. is considering the following five independent projects:
Project
A
B
C
D
E
Required Amount
of Capital
IRR
$300,000
25.35%
500,000
23.22%
400,000
19.10%
550,000
9.25%
650,000
8.50%
The company has a target capital structure which is 40 percent debt and 60 percent equity. The company
can issue bonds with a yield to maturity of 10 percent. The company has $900,000 in retained earnings,
and the current stock price is $40 per share. The flotation costs associated with issuing new equity are $2
per share. Mulva's earnings are expected to continue to grow at 5
percent per year. Next year's dividend (D1) is forecasted to be $2.50. The firm faces a 40 percent tax rate.
What is the size of Mulva's capital budget?
$1,200,000 $1,750,000 $2,400,000 $800,000
Ans.
$1,750,000
Logg Company is planning to buy a coin-operated machine costing P40,000. For tax purposes, this
machine will be depreciated over a five-year period using the straight-line method and no residual value.
Assume that the investment tax credit is not applicable to this purchase. Logg estimates that this
machine will yield an annual cash inflow, net of depreciation and income taxes, of P12,000. At the
following discount rates, the net present values of the investment are:
Discount
Net present
rate
value
12% + P3,258
14% + 1,197
16% 708
18% - 2,474
Logg’s desired rate of return on its investment is 12%.
Logg’s expected internal rate of return on its investment in this machine is?
3.3% 10.0% 12.0% 15.3%
Ans.
15.3%
The maximum acquisition value of an inefficiently run corporation is the discounted net present value of
the
Current market value of the firm.
Current earnings before interest and taxes (EBIT).
Current net profits.
Expected future cash flow.
Ans.
Expected future cash flow.
In order to increase production capacity, Rovic Industries is considering replacing an existing production
machine with a new technologically improved machine effective January 1, 2014. The following
information is being considered by Gunning Industries:
•
The new machine would be purchased for P160,000 in cash. Shipping and installation would cost
an additional P30,000.
•
The new machine is expected to increase annual sales by 20,000 units at a sales price of P40 per
unit. Incremental operating costs include P30 per unit in variable cost and total fixed costs of P40,000
per year.
•
The investments in the new machine will require an immediate increase in working capital of
P35,000. This cash outflow will be recovered at the end of year 5.
•
Rovic uses straight-line depreciation for financial reporting and tax reporting purposes. The new
machine has an estimated useful life of five years and zero residual value.
•
Rovic is subject to a 40% corporate income tax rate.
Rovic uses the net present value method to analyze investments and will employ the following factors
and rates:
Present Value of an Ordinary
Period Present Value of P1 at 10%
Annuity of P1 at 10%
1
909
909
2
826
1.736
3
751
2.487
4
683
3.170
5
621
3.791
Rovic Industries’ discounted annual depreciation tax shield for the year 2014 is?
P13,817 P16,762 P20,725 P22,800
Ans.
P13,817
When ranking two mutually exclusive investments with different initial amounts, management should
give first priority to the project?
That generates cash flows for the longer period of time.
Whose net after-tax flows equal the initial investment.
That has the greater accounting rate of return.
That has the greater profitability index.
Ans.
That has the greater profitability index.
If the net present value (NPV) of Project A is known to be higher than the NPV of Project B, it can be
concluded that?
The internal rate of return (IRR) of Project A will definitely be higher than the IRR of Project B.
The IRR of Project A will definitely be lower than the IRR of Project B.
The ranking of IRRs is indeterminate based on the information provided.
The payback period for Project A is definitely shorter than the payback period for Project B.
Ans.
The ranking of IRRs is indeterminate based on the information provided.
CMA 0694 4-14
The tax impact of equipment depreciation affects capital budgeting decisions. Currently, the Modified
Accelerated Cost Recovery System (MACRS) is used as the depreciation method for most assets for tax
purposes.
When employing the MACRS method of depreciation in a capital budgeting decision, the use of MACRS
as compared with the straight-line method of depreciation will result in?
Equal total depreciation for both methods.
MACRS producing less total depreciation than straight line.
Equal total tax payments, after discounting for the time value of money.
MACRS producing more total depreciation than straight line.
Ans.
Equal total depreciation for both methods.
A firm with an 18% cost of capital is considering the following projects (on January 1, 2014):
January 1, 2014 December 31, 2010
Cash Outflow Cash Inflow
Project Internal
(000’s Omitted) (000’s Omitted) Rate of Return
Project A
P 3,500 P 7,400 16%
Project B
4,000 9,950 ?
Present value of P1 Due at the End of “N” Periods
C
12%
14%
15%
16%
18% 20%
22%
4
.6355 .5921 .5718 .5523 .5158 .482
.4230
5
.5674 .5194 .4972 .4371 .4371 .4019 .3411
6
.5066 .4556 .4323 .4101 .3704 .3349 .2751
Project B’s internal rate of return is closest to
15% 16% 18% 20%
Ans.
20%
CMA 0695 4-2
Sensitivity analysis, if used with capital projects,
Is used extensively when cash flows are known with certainty.
Measures the change in the discounted cash flows when using the discounted payback method rather
than the net present value method.
Is a "what-if" technique that asks how a given outcome will change if the original estimates of the
capital budgeting model are changed.
Is a technique used to rank capital expenditure equests.
Ans.
Is a "what-if" technique that asks how a given outcome will change if the original estimates of the capital
budgeting model are changed.
CMA 1292 4-19
The proper discount rate to use in calculating certainty equivalent net present value is the?
Risk-adjusted discount rate.
Cost of capital.
Risk-free rate.
Cost of equity capital
Ans.
Risk-free rate.
Suzie owns a computer reselling business and is expanding her business. Suzie is presented with one
proposal, Proposal A, such that the estimated investment for the expansion project is $85,000, and it is
expected to produce cash flows after taxes of $25,000 for each of the next 6 years. An alternate
proposal, Proposal B, involves an investment of $32,000 and after-tax cash flows of
$10,000 for each of the next 6 years. The cost of capital that would make Suzie indifferent between
these two proposals lies between
10% and 12%
14% and 16%
16% and 18%
18% and 20%is incorrect because Proposal A would be superior.
Ans.
16% and 18%
Amster Corporation has not yet decided on its hurdle rate for use in the evaluation of capital budgeting
projects. This lack of information will prohibit Amster from calculating a project’s
Accounting
Rate of Return
No
Yes
No
No
Ans.
No
Net
Present Value
No
Yes
Yes
Yes
Yes
Internal
Rate of Return
No
Yes
Yes
No
No
Net working capital is the difference between
Current assets and current liabilities.
Fixed assets and current liabilities.
Total assets and total liabilities.
Shareholders’ investment and cash.
Ans.
Current assets and current liabilities.
As a company becomes more conservative in working capital policy, it would tend to have a(an)
Decrease in its acid-test ratio
Increase in the ratio of current liabilities to non-current liabilities.
Increase in the ratio of current assets to units of output
Increase in funds invested in common stock and a decrease in funds invested in marketable securities.
Ans.
Increase in the ratio of current assets to units of output
Determining the appropriate level of working capital of the firm requires
Evaluating the risk associated with various levels of fixed assets and the types of debt used to finance
those assets.
Changing the capital structure and dividend policy of the firm.
Maintaining a high proportion of liquid assets to total assets in order to maximize the return on total
investment.
Offsetting the profitability of technical insolvency.
Ans.
Offsetting the profitability of technical insolvency.
Which of the following is not a use of working capital?
Repurchase of common stock
Purchase of inventory on account
Purchase of equipment of account
Repayment of long-term debt.
Ans.
Purchase of inventory on account
All of the following statements in regard to working capital are correct except:
Current liabilities are an important source of financing for many small firms.
Profitability varies inversely with liquidity
The hedging approach to financing involves matching maturities of debt with specific financing needs
Financing permanent inventory buildup with long-term debt is an example of an aggressive working
capital policy
Ans.
Financing permanent inventory buildup with long-term debt is an example of an aggressive working
capital policy
The amortization of goodwill appearing in the income statement is?
Deducted from profit to obtain “Funds provided by operations”
Added to profit to obtain “Funds provided by operation”.
A source of working capital separate from profit.
A use of working capital
Ans.
Added to profit to obtain “Funds provided by operation”.
The fundamental analysis of cash flow generated from operations may be determined using any of the
following except:
After tax income plus depreciation
Profit less depreciation plus taxes
Profit plus depreciation
Cash sales less cash operating costs less taxes paid
Ans.
Profit less depreciation plus taxes
Net working capital is the difference between
Current assets and current liabilities.
Fixed assets and current liabilities.
Total assets and total liabilities.
Shareholders’ investment and cash.
Ans.
Current assets and current liabilities.
Which one of the following transactions would increase the current ratio and decrease net profit?
An income tax payment due from the previous year is paid.
A stock dividend is declared.
Uncollectible accounts receivable are written off against the allowance account
Vacant land is sold for less than the net book value.
Ans.
Vacant land is sold for less than the net book value.
Net working capital is the difference between?
Current assets and current liabilities
Fixed assets and current liabilities
Total assets and total liabilities
Shareholders’ investment and cash
Ans.
Current assets and current liabilities
Which of the following would reduce the additional funds required if all other things are held constant?
A decrease in the company’s tax rate
An increase in the expected sales growth rate.
An increase in the dividend payout ratio.
A decrease in the profit margin
Ans.
A decrease in the company’s tax rate
Which one of the following transactions does not change the current ratio and does not change the
total current assets?
A cash advance is made to a divisional office.
A cash dividend is declared.
Short-term notes payables are retired with cash.
A fully depreciated asset is sold for cash.
Ans.
A cash advance is made to a divisional office.
Determining the appropriate level of working capital for a firm requires
Changing the capital structure and dividend policy of the firm.
Maintaining short-term debt at the lowest possible level because it is generally more expensive than
long-term debt.
Offsetting the benefit of current assets and current liabilities against the probability of technical
insolvency.
Maintaining a high proportion of liquid assets to total assets in order to maximize the return on total
investments.
Ans.
Offsetting the benefit of current assets and current liabilities against the probability of technical
insolvency.
Determining the appropriate level of working capital for a firm requires
Changing the capital structure and dividend policy of the firm.
Maintaining short-term debt at the lowest possible level because it is generally more expensive than
long-term debt.
Offsetting the benefit of current assets and current liabilities against the probability of technical
insolvency.
Maintaining a high proportion of liquid assets to total assets in order to maximize the return on total
investments.
Ans.
Offsetting the benefit of current assets and current liabilities against the probability of technical
insolvency.
Which of the following account changes would be classified as a use of funds?
An increase in accounts payable
An increase in retained earnings
A decrease in bonds payable
A decrease in accounts receivable
Ans.
A decrease in bonds payable
The working capital RED Company at December 31, 2017 was P10,000,000. Selected information for the
year 2018 for RED Company is as follows:
Working capital provided from operations
P1,700,000
Capital expenditure
3,000,000
Proceeds from short-term borrowings 1,000,000
Proceeds from long-term borrowings 2,000,000
Payments on short-term borrowings
500,000
Payments on long-term borrowings
600,000
Proceeds from issuance of common stock
1,400,000
Dividends paid on common stock
800,000
What is RED working capital at December 31, 2018?
P11,200,000 P11,500,000 P10,700,000 P12,000,000
Ans.
P10,700,000
Compared to other firms in the industry, a company that maintains a conservative working capital policy
will tend to have a?
Greater percentage of short-term financing
Greater risk of needing to sell current assets to repay debt.
Higher ratio of current assets to fixed assets
Higher total asset turnover
Ans.
Higher ratio of current assets to fixed assets
Determining the appropriate level of working capital for a firm requires:
Changing the capital structure and dividend policy of the firm
Maintaining short-term debt at the lowest possible level because it is generally more expensive than
long-term debt
Offsetting the benefit of current assets and current liabilities against the probability of technical
insolvency
Maintaining a high proportion of liquid assets to total assets in order to maximize the return on total
investments.
Ans.
Offsetting the benefit of current assets and current liabilities against the probability of technical
insolvency
Management of a company does not want to violate a working capital restriction contained in its bond
indenture. If the firm’s current ratio falls below 2.0 to 1, technically it will have defaulted. The firm’s
current ratio is now 2.2 to 1. If current liabilities are P200 million, the maximum new commercial paper
that can be issued to finance inventory expansion is?
P20 million P40 million P240 million P180 million
Ans.
P40 million
Spotech Company’s 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 Spotech 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?
P165,625 P
0 P3,312,500 P 828,125
Ans.
P165,625
Bankerohan Company used the working capital basis of preparing its Fund Flow Statement. The following
data are presented for the year just ended:
Depreciation expense P48,500
Amortization of patents 12,000
Cash dividends declared27,000
Cash dividends paid
34,000
Bonds payable issued 90,000
Sale of common stock 175,000
Amortization of bonds discount 1,500
Gain on sale of equipment
9,500
Working capital provided by operations 121,000
Purchase of land
310,000
Decrease in deferred income taxes
18,000
Calculate the profit or loss for the period from the above data.
P68,500 P86,500 P113,500 P351,500
Ans.
P68,500
MFA Corporation has 100,000 shares of stock outstanding. Below is part of MFC’s Statement of Financial
Position for the last fiscal year.
MFA Corporation
Statement of Financial Position – Selected Items
December 31, 20CY
Cash P455,000
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
P2.05 P2.50 P3.35 P3.80
Ans.
P2.50
65,000
During 20CY, Mason Company’s current assets increased by P120, current liabilities decreased by P50,
and net working capital
Increased by P70 Did not change Decreased by P170 Increased by P170
Ans.
Increased by P170
In cash management, which of the following statements is false?
Capital costs, delinquency costs, and default costs are costs associated with cash management.
Short costs, long costs, and procurement costs are costs associated with optimal cash balance model
approach
Obtaining financing services and controlling cash flow are some of the major functions of cash
management.
Funds sourcing and custodianship must be done at the lowest possible cost, where excess funds must be
invested for a return that is best in the market.
Ans.
Short costs, long costs, and procurement costs are costs associated with optimal cash balance model
approach
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.
Access to Mel’s inventory balances of Franklin’s products.
Better status of deliveries and payments
Compatibility with Franklin’s other procedures and systems
Reduction in the payment float
Ans.
Reduction in the payment float
Which of the following actions are likely to reduce the length of a company’s cash conversion cycle?
Adopting a just-in-time inventory system that reduces the inventory conversion period. Reducing the
average days sales outstanding (DSO) on its accounts receivable.
Reducing the amount of time the company takes to pay its suppliers.
Statements a and b are correct.
Ans.
Statements a and b are correct.
An enterprise plans to produce a new product, which will typically be sold to other firms on credit. The
cash conversion cycle resulting from this new product can be measured as the length of time from?
Cash purchases of raw materials to the collection of accounts receivable.
Cash purchases of raw materials to the time the final product is completed.
Cash purchases of raw materials to the sale of the product.
When the product is completed to the sale of the product.
Ans.
Cash purchases of raw materials to the collection of accounts receivable.
Which of the following statements is most correct?
A good cash management system would minimize disbursement float and maximize collections float.
If a firm begins to use a well-designed lockbox system, this will reduce its customers’ net float.
In the early 1980s, the prime interest rate hit a high of 21 percent. In 2000 the prime rate was
considerably lower. That sharp interest rate decline has increased firms’ concerns about the efficiency of
their cash management programs.
A firm that has such an efficient cash management system that it has positive net float can have a
negative checkbook balance at most times and still not have its checks bounce.
Ans.
A firm that has such an efficient cash management system that it has positive net float can have a
negative checkbook balance at most times and still not have its checks bounce.
Which of the following are criteria for selection among securities available for a marketable securities
portfolio?
Default risk, taxability, and relative yields
Planning, major investment decisions, and interaction with capital markets.
The operating, payment, and cash conversion cycles.
Inventory conversion, receivables conversion, and payable deferral periods.
Ans.
Default risk, taxability, and relative yields
A precautionary motive for holding excess cash is?
To enable a company to meet the cash demands from the normal flow of business activity.
To enable a company to avail itself of a special inventory purchase before prices rise to higher levels.
To enable a company to have cash to meet emergencies that may arise periodically.
To avoid having to use the various types of lending arrangements available to cover projected cash
deficits.
Ans.
To enable a company to have cash to meet emergencies that may arise periodically.
Firms would need to hold zero cash when:
Transaction-related needs are greater than cash inflows
Transaction-related needs are less than cash inflows
Transaction-related needs are not perfectly synchronized with cash inflows
Transaction-related needs are perfectly synchronized with cash inflows
Ans.
Transaction-related needs are perfectly synchronized with cash inflows
According to the hedging principle (or the principle of self-liquidating debt), in making decisions
concerning the maturity structure of an entity’s financing, which one of the following guidelines would
be most appropriate?
Fund a project with short-term benefits by issuing common stock.
Fund a seasonal expansion in inventory by issuing bonds.
Fund a project that will benefit eight years with a short-term note.
Fund a permanent expansion in accounts receivable by issuing long-term bonds.
Ans.
Fund a permanent expansion in accounts receivable by issuing long-term bonds.
The following are desirable in cash management except:
Cash is collected at the earliest time possible.
Most sales are on cash basis and receivables are aged “current”
Post-dated checks are not deposited on time upon maturity.
All sales are properly receipted and promptly deposited intact.
Ans.
Post-dated checks are not deposited on time upon maturity.
A large firm may hold substantial cash balances because:
These balances are required by the bank
The company may have accounts in many different banks
The company may have a very decentralized organization.
All of the above
Ans.
All of the above
When a company is evaluating whether the ratio of cash and marketable securities to total assets should
be high or low, its decision will be based upon
Financial leverage considerations
Operating leverage considerations
Risk-profitability trade-off considerations
Flotation cost considerations
Ans.
Risk-profitability trade-off considerations
Which of the following actions would not be consistent with good management?
Increased synchronization of cash flows.
Minimize the use of float.
Maintaining an average cash balance equal to that required as a compensating balance or that which
minimizes total cost.
Use of checks and drafts in disbursing funds.
Ans.
Use of checks and drafts in disbursing funds.
In managing its working capital, your firm tries to follow the hedging principle of finance. Which one of
the following would be too aggressive to be consistent with that principle as applied to working capital?
Financing short-term needs with long-term funds.
Financing long-term needs with short-term funds.
Financing seasonal needs with short-term funds.
Financing a permanent build-up in inventory with long-term debt.
Ans.
Financing long-term needs with short-term funds.
A company’s management is concerned about the large bank overdraft, which it wishes to reduce over
the budget period of one year. Which one of the four items below will not necessarily result in a lower
bank overdraft?
Reducing bad debts
Taking longer credit from suppliers without any loss of discounts.
Reducing wastage and loss through damage of regularly-used stock items.
Reducing unit costs of production.
Ans.
Reducing bad debts
Ignoring cost and other effects on the firm, which of the following measures would tend to reduce the
cash conversion cycle?
Maintain the level of receivables as sales decrease.
Buy more raw materials to take advantage of price breaks.
Buy more raw materials to take advantage of price breaks.
Forgo discounts that are currently being taken.
Ans.
Forgo discounts that are currently being taken.
According to John Maynard Keynes, the three major motives for holding cash are for?
Transactional, psychological, and social purposes.
Speculative, fiduciary, and transactional purposes.
Speculative, social, and precautionary purposes.
Transactional, precautionary, and speculative purposes.
Ans.
Transactional, precautionary, and speculative purposes.
Which of the following is not a situation that might lead a firm to hold marketable securities?
The firm has purchased a fixed asset that will require a large write-off of depreciable expense.
The firm must meet a known financial commitment, such as financing an ongoing construction project.
The firm must finance seasonal operations.
The firm has just sold long-term securities and has not yet invested the proceeds in earning assets.
Ans.
The firm has purchased a fixed asset that will require a large write-off of depreciable expense.
Most large firms hold a cash balance greater than most models imply because:
It is too difficult to estimate the costs of security transactions.
Banks are compensated by account balances for payment of services.
Corporations have few bank accounts and it is difficult to manage their cash.
Cash is costless and need not be managed closely.
Ans.
Banks are compensated by account balances for payment of services.
The criteria that should be considered in investing surplus cash.
Safety of the company’s funds
Liquidity of the principal
Yield on the principal
All of the above
Ans.
All of the above
Which of the following is not a major function in cash management?
Cash flow control
Cash surplus investment
Maximizing sales
Obtaining financing services
Ans.
Maximizing sales
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
P60,000 P66,000 P49,000 P71,000
Ans.
P71,000
Which of the following statements concerning zero balance accounts is not correct?
They are set up to handle disbursement activity.
The account has a minimum amount at all times.
Checks are automatically transferred into the account as checks presented for payment.
The transfer is automatic and involves an accounting entry only.
Ans.
The account has a minimum amount at all times.
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
1 and 5 1, 3, 4, and 5 1, 2 and 5 1, 4 and 5
Ans.
1 and 5
In general, as a company increases the amount of short-term financing relative to long-term financing,
the?
Greater the risk that it will be unable to meet principal and interest payments
Leverage of the firm increases
Likelihood of having idle liquid assets increases
Current ratio increases
Ans.
Greater the risk that it will be unable to meet principal and interest payments
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?
All statements
Statements 1, 3, and 4 only
Statements 3 and 4 only
Statement 4 only
Ans.
Statements 3 and 4 only
Helena Furnishings wants to sharply reduce its cash conversion cycle. Which of the following steps would
reduce its cash conversion cycle?
The company increases its average inventory without increasing its sales.
The company reduces its DSO.
The company starts paying its bills sooner, which reduces its average accounts payable without reducing
its sales.
Statements a and b are correct.
Ans.
The company reduces its DSO.
A corporation obtains a loan of P200,000 at an annual rate of 12%. The corporation must keep a
compensating balance of 20% of any amount borrowed on the deposit at the bank but it normally does
not have a cash balance account with the bank. What is the effective cost of the loan?
12.0% 13.3% 15.0% 16.0%
Ans.
15.0%
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?
18.2% 20.0% 22.2% 25.0%
Ans.
25.0%
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?
6.44% 7.00% 5.80% 6.66%
Ans.
6.44%
Beta Company has arranged to borrow P10,000 for 180 days. Beta will repay the principal amount plus
P600 in interest at the maturity of the note.
Which one of the following is the annual percentage rate (APR) of interest that Beta is paying on the
loan?
3.0% 6.0% 12.0% 16.6%
Ans.
12.0%
The treasury analyst for KG Manufacturing has estimated the cash flows (in millions) for the first half of
next year (ignoring any short-term borrowings) as follows:
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?
Zero P61,000 50,000 P132,000
Ans.
P61,000
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
18.2% 20.0% 22.2% 25.0%
Ans.
25.0%
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
The net proceeds of the loan was P1 million. The principal amount of the loan was
P1,176,471 P1,000,000 P1,492,537 P1,219,512
Ans.
P1,492,537
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?
13.20% 12.67% 12% 13.5%
Ans.
12.67%
CMA 0689 1-25
All of the following are examples of imputed costs except
The stated interest paid on a bank loan.
Assets that are considered obsolete that maintain a net book value.
Decelerated depreciation
Lending funds to a supplier at a lower-than-market rate in exchange for receiving the supplier's products
at a discount.
Ans.
The stated interest paid on a bank loan.
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:
19.05% 20.00% 22.85% 25.00%
Ans.
25.00%
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
Bank loan since its cost of 11.11% is cheaper than the cost of delaying payments of 12.24%.
Delaying payments since it has no cost compared to the 10% discounted bank interest.
Bank loan since it costs of 10% is cheaper than the cost of delaying payments of 12%.
Delaying payments since it costs only 2% compared to 10% discounted bank interest.
Ans.
Bank loan since its cost of 11.11% is cheaper than the cost of delaying payments of 12.24%.
Alpha Company borrowed P20,000 from High Bank, giving one-year note. The terms of the note
provided for 6% interest and required a 10% compensating balance. Which one of the following is the
effective rate of interest on the loan?
4.0% 6.0% 6.7% 10.0%
Ans.
6.7%
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?
5.83% 7.00% 6.40% 8.75%
Ans.
8.75%
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?
6.44% 7.00% 5.80% 6.66%
Ans.
6.44%
The effective interest rate for short-term borrowing is computed as follows:
Borrowing costs plus savings divided by net proceeds.
Borrowing costs minus income directly related to borrowing minus savings divided by principal less
discounted fees and expenses and incremental compensating balances.
(Net proceeds divided net borrowing costs) minus 1
Net borrowing costs divided market price less transaction costs.
Ans.
Borrowing costs minus income directly related to borrowing minus savings divided by principal less
discounted fees and expenses and incremental compensating balances.
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 one-month period. What is the average cash balance (rounded to the
nearest peso)?
P1,000 P2,000 P3,464 P6,928
Ans.
P3,464
When a company is evaluating whether the ratio of cash and marketable securities to total assets should
be high or low, its decision will be based upon:
Financial leverage considerations.
Operating leverage considerations.
Risk-profitability trade-off considerations.
Flotation cost considerations.
Ans.
Risk-profitability trade-off considerations.
Concerning the Baumol model, which of the following is not correct (all other things equal)?
The optimum cash balance is higher at higher interest rates.
The optimum cash balance is higher at higher fixed order costs.
The optimum cash balance is higher at higher total cash requirement.
All of the above are correct.
Ans.
All of the above are correct.
Baumol's model of cash balances states that: Q = [(2 x T x C./i]^0.5 where T = annual cash disbursement,
C = cost per sale of T-bills, i = interest rate. What is Q?
The number of times per annum bill should be sold.
The average holding of bills
The amount of T-bills that should be sold at any one time.
The minimum holding of cash.
Ans.
The amount of T-bills that should be sold at any one time.
Some managers express the opinion that “cash management problems are nothing more than inventory
problems.” They then proceed to use cash management module, such as the EOQ model to determine
the:
Credit and collection policies.
Marketable securities level.
Proper relationship between current assets and current liabilities.
Proper blend of marketable securities and cash.
Ans.
Proper blend of marketable securities and cash.
Determining the amount and timing of conversions of marketable securities to cash is a critical element
of a financial manager's performance. In terms of the rate of return forgone on converted securities and
the cost of such transactions, the optimal amount of cash to be raised by selling securities is?
Inversely related to the rate of return forgone and directly related to the cost of the transaction.
Directly related to the rate of return forgone and directly related to the cost of the transaction.
Directly related to the rate of return forgone and inversely related to the cost of the transaction.
Inversely related to the rate of return forgone and inversely related to the cost of the transaction.
Ans.
Inversely related to the rate of return forgone and directly related to the cost of the transaction.
The economic order quantity (EOQ) formula can be adapted in order for a firm to determine the optimal
mix between cash and marketable securities. The EOQ model assumes all of the following except:
The cost of a transaction is independent of the dollar amount of the transaction and interest rates are
constant over the short run.
An opportunity cost is associated with holding cash, beginning with the first dollar.
The total demand for cash is known with certainty.
Cash flow requirements are random.
Ans.
Cash flow requirements are random.
When managing cash and short-term investments, a corporate treasurer is primarily concerned with?
Maximizing rate of return.
Minimizing taxes.
Investing in Treasury bonds since they have no default risk.
Liquidity and safety.
Ans.
Liquidity and safety.
We should expect cash balances to increase when:
The transaction costs of buying or selling interest-bearing securities increase
Interest rates increase
Sales volume falls
Uncertainty about day-to-day or week-to-week cash flows decreases
Ans.
Uncertainty about day-to-day or week-to-week cash flows decreases
Baumol's model of cash balances states that: Q = [(2 x T x C./i]^0.5 where T = annual cash disbursement,
C = cost per sale of T-bills, i = interest rate. What is Q?
The number of times per annum bill should be sold.
The average holding of bills
The amount of T-bills that should be sold at any one time.
The minimum holding of cash.
Ans.
The amount of T-bills that should be sold at any one time.
The Baumol cash balance model is limited by:
Assuming the cash flows are variable across the period.
A smooth disbursement rate and now cash inflows over the period.
Having a safety stock set to zero.
Both B and C.
Ans.
Both B and C.
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?
P10,000 P
0 P(10,000) P50,000
Ans.
P10,000
An automated clearing house (ACH) electronic transfer is a(an)
Electronic payment to a company’s account at a concentration bank.
Check that must be immediately cleared by the Bangko Sentral ng Pilipinas.
Computer-generated deposit ticket verifying deposit of funds.
Check like instrument drawn against the payer and not against the bank.
Ans.
Electronic payment to a company’s account at a concentration bank.
A working capital technique that increases the payable float and therefore delays the outflow of cash is
Concentration banking.
A draft
Electronic data interchange (EDI).
A lockbox system.
Ans.
A draft
Electronic cash transfers offer several advantages, including:
A low marginal transactions cost
A reduced float
Easy automation of record-keeping
All of the above
Ans.
All of the above
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 shortterm 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 P0.50 per check.
A flat fee of P125,000 per year.
A fee of 0.03% of the amount collected.
A compensating balance of P1,750,000.
Ans.
A compensating balance of P1,750,000.
Banks generally offer the following cash management services:
Processing checks Transferring funds Running lock-boxes All of the above
Ans.
All of the above
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
P1,200,000 P 750,000 P600,000 P450,000
Ans.
P1,200,000
The best example of a marketable security with minimal risk would be
Municipal bonds.
The common stock of a Aaa rated company.
Gold.
The commercial paper of a Aaa-rated company.
Ans.
The commercial paper of a Aaa-rated company.
Banks generally offer the following services:
Processing checks
Running lock-boxes
Providing advice and references
All of the above
Ans.
All of the above
A working capital technique that increases the payable float and therefore delays the outflow of cash is
Concentration banking.
A draft.
Electronic data interchange (EDI).
A lockbox system.
Ans.
A draft.
Banks generally offer the following cash management services:
Processing checks Transferring funds Running lock-boxes All of the above
Ans.
All of the above
A working capital technique that increases the payable float and therefore delays the outflow of cash is?
Concentration banking.
A draft.
Electronic data interchange (EDI).
A lockbox system.
Ans.
A draft.
A typical firm doing business nationally cannot expect to accelerate its cash inflow by
Establishing multiple collection centers throughout the country
Employing a lockbox arrangement
Initiating controls to accelerate the deposit and collection of large checks
Maintaining compensating balances rather than paying cash for bank services.
Ans.
Maintaining compensating balances rather than paying cash for bank services.
Checks written by the firm are said to generate:
Availability float Ledger float Disbursement float Book float
Ans.
Disbursement float
The difference between bank cash and book cash is called:
Disbursement float Net float Availability float None of the above
Ans.
Disbursement float
Methods of accelerating cash collections include all of the following except:
Decentralized collections.
Electronic funds transfers.
Compensating balances.
Lockbox systems.
Ans.
Compensating balances.
The fastest but most expensive way to transfer surplus funds from the local deposit bank to the
concentration bank is:
A lock-box system
A mail float system
A wire transfer
An in-house processing float system
Ans.
A wire transfer
Which of the following is a way for companies to speed up collections?
Remote disbursing Concentration banking Baumol model All of the above
Ans.
Concentration banking
A check processed through ACH (Automated Clearing House):
Will clear immediately
Will clear the same day
Will take two or three days to clear
None of the above
Ans.
Will take two or three days to clear
A working capital technique that delays the outflow of cash is?
Factoring A draft A lock-box system Electronic funds transfer
Ans.
A draft
An automated clearing house (ACH) electronic transfer is a(n)
Electronic payment to a company’s account at a concentration bank.
Check that must be immediately cleared by the Federal Reserve Bank.
Computer-generated deposit ticket verifying deposit of funds.
Check-like instrument drawn against the payor and not against the bank.
Ans.
Electronic payment to a company’s account at a concentration bank.
A lockbox plan is most beneficial to firms that
Send payables over a wide geographic area.
Have widely disbursed manufacturing facilities.
Have a large marketable securities account to protect.
Make collections over a wide geographic area
Ans.
Make collections over a wide geographic area
Which one of the following is not a characteristic of a negotiable certificate of deposit? Negotiable
certificates of deposit
Have a secondary market for investors.
Are regulated by the Bangko Sentral ng Pilipinas.
Are usually sold in denominations of a minimum of P100,000.
Have yields considerably greater than bankers’ acceptances and commercial paper.
Ans.
Have yields considerably greater than bankers’ acceptances and commercial paper.
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?
135 days 90 days C 105 days
Ans.
C
By getting closer to the source of payment, lock-boxes can be used to reduce:
Availability or clearing float
Mail float
In-house processing float
Disbursement float
Ans.
Mail float
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?
P 3,000 P12,000 P
0 P6,000
Ans.
P6,000
Which of the following is used to control disbursements?
Concentration banking Zero-balance account Lock-box system Fedwire
Ans.
Zero-balance account
A cash management system should be concerned with the float associated with both cash receipts and
cash disbursement. Will efficient practices seek to increase or decrease receipt float and disbursement
float?
Receipt
Disbursement
Float
Float
Increase
Increase
Increase
Decrease
Decrease
Increase
Decrease
Decrease
Ans.
Decrease
Increase
The following practices will impact the cash flow of the company:
Sales personnel are unequivocally responsible for collecting their credit sales.
Sales commissions are based on collected invoices.
Statement of accounts receivable are reconciled with customers and regularly sent for confirmation.
Automatic transfer of funds is arranged with banks regarding deposits of branches.
Ans.
Automatic transfer of funds is arranged with banks regarding deposits of branches.
Which of the following actions would not be consistent with good management?
Increased synchronization of cash flows.
Minimize the use of float.
Maintaining an average cash balance equal to that required as a compensating balance or that which
minimizes total cost.
Use of checks and drafts in disbursing funds.
Ans.
Minimize the use of float.
The most common cash management technique used to speed up collections is:
Concentration banking Wire transfers Lock-boxes In-house processing
Ans.
Lock-boxes
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 average 6% during the year, the additional annual
income (loss) of using the lockbox system is
P(24,000) P12,000 P30,000 P54,000
Ans.
P30,000
A compensating balance:
Compensates a financial institution for services rendered by providing it with deposits of funds.
Is used to compensate for possible losses on a marketable securities portfolio.
Is a level of inventory held to compensate for variations in usage rate and lead-time.
Is the amount of prepaid interest on a loan.
Ans.
Compensates a financial institution for services rendered by providing it with deposits of funds.
Which one of the following cash management techniques focuses on cash disbursements? Lock-box
system
Zero-balance account.
Pre-authorized checks.
Depository transfer checks.
Ans.
Zero-balance account.
Which one of the following short-term investments is likely to provide the greatest safety of principal?
Commercial paper
Banker’s acceptance.
Fannie Mae securities.
U.S. Treasury bills
Ans.
U.S. Treasury bills
Which of the following investments is not likely to be a proper investment for temporary idle cash?
Initial public offering of an established profitable conglomerate.
Commercial paper.
Treasury bills.
Treasury bonds due within one year.
Ans.
Treasury bonds due within one year.
For which of the following investments is there a very active secondary market?
Medium-term notes
Commercial paper
US Treasury bills
Repurchase agreements
Ans.
US Treasury bills
Even though the dividend rate on a floating-rate preferred stock is floating to keep in line with interest
rates, the instrument still suffers from risk such as:
A thin market causing potential principal risk and liquidity concerns.
The risk of downgrades from the narrow range of issuers.
The impact of tax law changes, which may reduce the after-tax value of the instrument.
All of the above
Ans.
All of the above
All of the following are valid reasons for a business to hold cash and marketable securities except to
Satisfy compensating balance requirements.
Maintain adequate cash needed for transactions.
Meet future needs.
Earn maximum returns on investment assets
Ans.
Earn maximum returns on investment assets
The best example of a marketable security with minimal risk would be.?
Municipal bonds.
The common stock of a Aaa rated company.
Gold.
The commercial paper of a Aaa-rated company
Ans.
The commercial paper of a Aaa-rated company
All of the following are alternative marketable securities suitable for investment except
RP Treasury Bills Eurodollars. Commercial paper. Convertible bonds.
Ans.
Convertible bonds.
Floating-rate preferred stock offers competitive rates of return with traditional money-market
instruments but:
Is not rated by Moody's or Standard & Poor's
Still provides the corporate investor with the tax exclusion on dividend income
Has a fixed rate of dividend income
Offers a highly competitive trading market
Ans.
Still provides the corporate investor with the tax exclusion on dividend income
Negotiable CDs are issued by:
US Government Federal agencies Banks Corporations
Ans.
Banks
Which of the following statement completions is most correct? If the yield curve is upward sloping, then
a firm’s marketable securities portfolio, assumed to be held for liquidity purposes, should be?
Weighted toward long-term securities because they pay higher rates.
Weighted toward short-term securities because they pay higher rates.
Weighted toward U. S. Treasury securities to avoid interest rate risk.
Weighted toward short-term securities to avoid interest rate risk.
Ans.
Weighted toward short-term securities to avoid interest rate risk.
Which one of the following would an importer of goods from a new foreign supplier most likely use to
assure the supplier of payment?
Line of credit. Letter of credit Trade account application Commercial paper.
Ans.
Letter of credit
Commercial papers sold in the international markets are called?
Negotiable commercial papers
EuroCommercial papers
MTNs
None of the above
Ans.
EuroCommercial papers
Which one of the following is not a characteristic of a negotiable certificate of deposit? Negotiable
certificates of deposit
Have a secondary market for investors.
Are regulated by the Federal Reserve System.
Are usually sold in denominations of a minimum of $100,000.
Have yields considerably greater than bankers' acceptances and commercial paper.
Ans.
Have yields considerably greater than bankers' acceptances and commercial paper.
All of the following are alternative marketable securities suitable for investment except:
U.S. Treasury bills Eurodollars. Commercial paper Convertible bonds.
Ans.
Convertible bonds.
Which of the following statements does not properly describe a Eurodollar deposit?
Eurodollar deposits are U.S. dollar deposits in banks outside of the U.S.
Eurodollar deposits are outside the direct control of the U.S. monetary authorities.
Eurodollar deposit rates tend to be lower than domestic U.S. rates on equivalent instruments.
Interest rates on Eurodollar deposits are tied to the London Interbank Offer Rate (LIBOR).
Ans.
Eurodollar deposit rates tend to be lower than domestic U.S. rates on equivalent instruments.
Of the following, a characteristic of Eurobonds is that they are?
Always denominated in Eurodollars.
Always sold in some country other than the one in whose currency the bond is denominated.
Sold outside the country of the borrower but are denominated in the currency of the country in which
the issue is sold.
Generally issued as registered bonds.
Ans.
Always sold in some country other than the one in whose currency the bond is denominated.
A variable rate demand bond (VRDB):
Is a long-term security.
Has interest payments linked to the level of short-term interest rates.
May periodically be sold back to the issuer at face value.
All of the above
Ans.
All of the above
"Eurodollars" or "international dollars" are:
Dollar deposits in banks outside the US
Dollars deposited in the US by foreigners
Dollars held by foreign governments
None of the above
Ans.
Dollar deposits in banks outside the US
The marketable securities with the least amount of default risk are?
Federal government agency securities.
U.S. Treasury securities.
Repurchase agreements.
Commercial paper.
Ans.
U.S. Treasury securities.
Interest rates received by depositors on Eurodollar deposits tend to be higher than domestic U.S. rates
on equivalent instruments because?
Borrowers pay higher rates than domestic U.S. rates on equivalent instruments.
The deposits involve different currencies.
Eurodollar deposits are for smaller amounts.
The Eurodollar market is outside the direct control of the U.S. monetary authorities and has lower costs.
Ans.
The Eurodollar market is outside the direct control of the U.S. monetary authorities and has lower costs.
Which one of the following is a formal legal commitment to extend credit up to some maximum amount
to a borrower over a stated period?
Letter of credit. Revolving credit agreement. Line of credit Trade credit.
Ans.
Revolving credit agreement.
The best example of a marketable security with minimal risk would be?
Municipal bonds.
The common stock of a Aaa rated company.
The commercial paper of a Aaa rated company.
Stock options of a Aaa rated company.
Ans.
The commercial paper of a Aaa rated company.
A tax-paying corporation would prefer to invest short-term money in:
Preferred stock
Floating-rate preferred stock
Common stock
Long-term bonds
Ans.
Floating-rate preferred stock
A repurchase agreement occurs when:
A company agrees to buy back its commercial paper before maturity.
A bank depositor agrees, in advance, to re-invest money in a negotiable certificate of deposit.
An investor buys part of a government security dealer's inventory and simultaneously agrees to sell it
back.
The federal government agrees to buy T-bills
Ans.
An investor buys part of a government security dealer's inventory and simultaneously agrees to sell it
back.
The risk that securities cannot be sold at a reasonable price on short notice is called?
Default risk Interest-rate risk. Purchasing-power risk. Liquidity risk
Ans.
Liquidity risk
Which security is most often held as a substitute for cash?
Treasury bills. Common stock Gold. Aaa corporate bonds.
Ans.
Treasury bills.
When making short-term investments, which one of the following is the risk associated with the ability
to sell an investment in a short period of time without having to make significant price concessions?
Purchasing power risk.
Interest rate risk.
Default risk.
Liquidity risk.
Ans.
Liquidity risk.
Which of the following consideration typically would be important in selecting investments for the
temporary use of “excess” cash?
AICPA.070717BEC-SIM
Ready
Safety of Principal
Marketability
Yes
Yes
Yes
No
No
Yes
No
No
Ans.
Yes
Yes
In smaller businesses in which the management of cash is but one of numerous functions performed by
the treasurer, various cost incentives and diversification arguments suggest that surplus cash should be
invested in?
Commercial paper
Bankers' acceptances.
Money market mutual funds.
Corporate bonds.
Ans.
Money market mutual funds.
The three money market securities with the greatest volume of business are:
Treasury bills, commercial paper, repurchase agreements
Negotiable CDs, federal agency discount notes, T-bills.
Commercial paper, bankers' acceptances, tax-exempt municipal notes
Federal agency discount notes, repurchase agreements, medium-term notes.
Ans.
Treasury bills, commercial paper, repurchase agreements
There is a difference between "Eurodollar" or "international dollar" rate and short-term interest rate in
the US because:
Banks are not subject to reserve requirements on international dollars.
Banks need not insure international dollar deposits with the FDIC.
Both A and B
None of the above
Ans.
Both A and B
On September 15, 20CY, DJ Corporation accepted from a customer a P100,000. 90-day 20% interest
bearing note dated on the same day. On October 15, 20CY, DJ discounted the note at the Western Bank
at a 23% discount rate. The customer paid the note at maturity. Based on a 360-day, what amount
should DJ report as net interest revenue from the note transaction? P 975 P20,000 P 5,000 P 4,025
Ans.
P 975
Kiks Company’s account balance at June 30, 20CY for accounts receivable and related allowances for
doubtful accounts were P600,000 and P3,000, respectively. Aging of accounts receivable indicated that
P48,000 of the June 30, 2018 receivable may be uncollectible. Net realizable value of accounts
receivable were.
P597,000 P552,000 P539,000 P540,000
Ans.
P552,000
A change in credit policy has caused an increase in sales, an increase in discounts taken, a reduction in
the investment in accounts receivables, and a reduction in the number of doubtful accounts. Based on
this information we know that?
The net profit has increased
The bad debt percentage has increased
The size of the discount offered has decreased
The average collection period has decreased
Ans.
The average collection period has decreased
It is held that the level of accounts receivable that the firm has or holds reflects both the volume of a
firm’s sales on account and a firm’s credit policies. Which one of the following items is not considered as
part of the firms’ credit policies?
The minimum risk group to which credit should be extended.
The extent (in terms of money) to which a firm will go to collect an account.
The length of time for which credit is extended.
The size of the discount that will be offered.
Ans.
The extent (in terms of money) to which a firm will go to collect an account.
In a set of comparative financial statements, you observed a gradual decline in the net to gross ratio,
(i.e., between net sales and gross sales). This indicates that:
There is stiffening in the grant of discounts to the customers
The discount period is being lengthened
There is adherence to the collection policies of the company
Sales volume is decreasing
Ans.
The discount period is being lengthened
The goal of credit policy is to
Extend credit to the point where marginal profits equal marginal costs.
Minimize bad debts losses.
Minimize collection expenses.
Maximize sales.
Ans.
Extend credit to the point where marginal profits equal marginal costs.
In preparing its budget for July 20CY, Lazel Company has the following accounts receivable information
available:
Accounts receivable at June 30, 20CY P 350,000
Estimated credited sales for July 400,000
Estimated collections in July for credit sales in July and prior months
320,000
Estimated write-offs in July for uncollectible credit sales 16,000
Estimated provision for doubtful accounts for credit sales in July 12,000
What is the projected balance of accounts receivable at July 31, 20CY?
P 402,000 P 430,000 P 414,000 P 426,000
Ans.
P 414,000
JBJ Company’s account balance at June 30, 1987 for account receivables and related allowances for
doubtful accounts were P600,000 and P3,000 respectively. Aging of accounts receivable indicated that
P48,000 of the June 30, 1987 receivable may be uncollectible. Net realizable value of accounts
receivable were:
P597,000 P552,000 P539,000 none of these
Ans.
P552,000
To improve the credit and collection policies of Maine Corporation, the following data for 20CY were
gathered for study:
Accounts receivable, January 1 P 112,000
Accounts receivable, December 31
140,000
Bad debts losses
6,300
Allowance for uncollectible accounts, January 1
10,500
Allowance for uncollectible accounts, December 31
7,000
Sales (all sales were made on credit)
630,000
What was the total cash collected from customers during 20CY?
P592,200 P598,500 P599,200 P605,500
Ans.
P592,200
The one item listed below that would warrant the least amount of consideration in credit and collection
policy decisions is the?
Quality of accounts accepted
Quantity discount given
Cash discount given
Level of collection expenditures
Ans.
Quantity discount given
A strict credit and collection policy is in place in Star Company. As Finance Director you are asked to
advice on the propriety of relaxing the credit standards in view of stiff competition in the market. Your
advice will be favorable if:
The competitor will do the same thing to prevent lost sales
There is a decrease in the distribution level of your product and a more aggressive stance is necessary to
retain market share
The projected margin from increased sales will exceed the cost of carrying the incremental receivables
The account receivable level is improving so the company can afford the carrying cost of receivables
Ans.
The projected margin from increased sales will exceed the cost of carrying the incremental receivables
By the end of the this year you expect to have a cash balance of P500,000. Which of these
transactions/indicators (not considered in your estimate) will reduce this balance
A modification on credit terms to customers will reduce credit sales
A dialogue with key suppliers will allow discounts on extended payment terms
A new machine will be bought with proceeds from a bank loan that will carry a 17% interest per annum
and monthly payments over 2 years
The ratio of current trade receivables to total receivables will decrease
Ans.
The ratio of current trade receivables to total receivables will decrease
It is held that the level of accounts receivable that the firm has or holds reflects both the volume of a
firm’s sales on account and a firm’s credit policies. Which one of the following items is not considered as
part of the firm’s credit policies?
The minimum risk group to which credit should be extended
The extent (in terms of money) to which a firm will go to collect an account
The length of time for which credit is extended
The size of the quantity discount that will be offered
Ans.
The size of the quantity discount that will be offered
The level of accounts receivable will most likely increase as:
Cash sales increase and number of days sales
Credit limits are expanded, credit sales increase, and credit terms remain the same
Credit limits are expanded, cash sales increase, and aging of the receivables is improved Cash sales
increase, current receivables ratio to past due increases, credit limits remain the same
Ans.
Credit limits are expanded, credit sales increase, and credit terms remain the same
It is held that the level of accounts receivable that the firm has or holds reflects both the volume of a
firm’s sales on account and a firm’s credit policies. Which one of the following items is not considered as
part of the firms’ credit policies?
The minimum risk group to which credit should be extended.
The extent (in terms of money) to which a firm will go to collect an account.
The length of time for which credit is extended.
The size of the discount that will be offered.
Ans.
The extent (in terms of money) to which a firm will go to collect an account.
The credit and collection policy of Levy Company provides for the imposition of credit block when the
credit line is exceeded and/or the account is past due. During the month, because of the campaign to
achieve volume targets, the general manager has waived the credit block policy in a number of instances
involving big volume accounts. The likely effect of this move is?
Deterioration of aging of receivables only
Increase in the level or receivables only
Deterioration of aging of receivables and increase in the level of receivables
Decrease in collections during the month the move was done
Ans.
Deterioration of aging of receivables and increase in the level of receivables
Which one of the following statements is most correct if a seller extends credit to a purchaser for a
period of time longer than the purchaser’s operating cycle? The seller.
Will have a lower of accounts receivable than those companies whose credit period is shorter than the
purchaser’s operating cycle
Is, in effect, financing more than just the purchaser’s inventory needs
Can be certain that the purchaser will be able to convert the inventory into cash before payment is due
Has no need for a stated discount rate or credit period
Ans.
Is, in effect, financing more than just the purchaser’s inventory needs
The accounts receivable balance is composed of the permanent and the fluctuating balances. The
permanent balance is justified on the following reason:
To accommodate business fluctuations in the economic environment.
To accommodate partially the working capital requirements of the customers. To stay competitive in the
market place.
The trade discount policy on credit sales imposes the creation of such a balance.
Ans.
To accommodate partially the working capital requirements of the customers.
A change in credit policy has caused an increase in sales, an increase in discounts taken, a reduction in
the investment in accounts receivable, and a reduction in the number of doubtful accounts. Based upon
the information, we know that
Net profit has increased
The average collection period has decreased
Gross profit has declined
The size of the discount offered has decreased
Ans.
The average collection period has decreased
The Sales Director of Go Company suggests that certain credit terms be modified. He estimates the
following effects:
·
Sales will increase by at least 20%.
·
Accounts receivable turnover will be reduced to 8 times from the present turnover of 10 times.
·
Bad debts, now at 1% of sales will increase to 1.5% Sales before the proposed changes are at
P900,000. Variable cost ratio is 55% and desired rate of return is 20% Fixed expenses amount to
P150,000.
Should the company allow the revision of its credit terns?
Yes, because income will increase by P64,800
Yes, because losses will be reduce by P78,800
No, because income will be reduced by P13,000
No, because losses will be increased by P28,000
Ans.
Yes, because income will increase by P64,800
If a firm had been extending trade credit on a 2/10, net/30 basis, what change would be expected on the
balance sheet of its customer if the firm went to a net cash 30 policy?
Increased payables and increased bank loan
Increased receivables
Decreased receivables
Decreased in cash
Ans.
Increased payables and increased bank loan
To improve the credit and collection policies of Maine Corporation, the following data for 20CY were
gathered for study:
Accounts receivable, January 1 P 112,000
Accounts receivable, December 31
140,000
Bad debts losses
6,300
Allowance for uncollectible accounts, January 1
10,500
Allowance for uncollectible accounts, December 31
7,000
Sales (all sales were made on credit)
630,000
What was the accounts receivable turnover (rounded to the nearest centavo)?
5.37 5.00 4.70 4.68
Ans.
5.00
When a company analyzes credit applicants and increases the quality of the accounts rejected, the
company is attempting to?
Maximize sales
Increase bad-debt losses
Increase the average collection period
Maximize profits
Ans.
Maximize profits
Prest Corp. plans to tighten its credit policy. Below is the summary of changes:
OLD
NEW
Average number of days collection
Ratio of credit sales to total sales
75
70%
50
60%
Projected sales for the coming year is P100 million and it is estimated that the new policy will result in a
5% loss if the new policy is implemented. Assuming a 360-day year, what is the effect of the new policy
on accounts receivable?
Decrease of P13 million
No change
Decrease of P5 million
Decrease of P 6.67 million
Ans.
Decrease of P 6.67 million
The Liberal Sales Co. budgeted sales for the coming year are P30 million of which 80% are expected to be
on credit. The company wants to change its credit terms from n/30 to 2/10, n/30. If the new credit
terms are adopted, the company estimates that cash discounts would be taken on 40% of the credit
sales and the new uncollectible amount would be unchanged. The adoption of the new credit terms
would result in expected discount availed of in the coming year of?
P600,000 P288,000 P480,000 P192,000
Ans.
P192,000
Slippers Mart has sales of P3 million. Its credit period and average collection period are both 30 days and
1% of its sales end up as bad debts. The general manager intends to extend the credit period to 45 days
which will increase sales by P300,000. However, bad debts losses on the incremental sales would be 3%.
Costs of products and related expenses amount to 40% exclusive of the cost carrying receivables of 15%
and bad debts expenses.
The change in the credit policy would result to increase (decrease) in incremental profit of:
P171,000 P106,000 P177,750 P161,250
Ans.
P161,250
A company serves as a distributor of products by ordering finished products once a quarter and using
that inventory to accommodate the demand over the quarter. If it plans to ease its credit policy for
customers, the amount of products ordered for its inventory every quarter will be?
Increased to accommodate higher sales levels
Reduced to offset the increased cost of carrying accounts receivable
Unaffected if safety stock is part of the current quarterly order
Unaffected if the JIT inventory control system is used
Ans.
Increased to accommodate higher sales levels
The Liberal Sales Company’s budgeted sales for the coming year are P30 millions of which 80% are
expected to be made on credit. The company wants to change its credit terms from n/30 to 2/10, n/30. If
the new credit terms are adopted, the company estimates that cash discounts would be taken on 40% of
the credit sales and the uncollectible amount would be unchanged. The adoption of the new credit
terms would result in expected discount availed of in the coming year of?
P600,000 P288,000 P480,000 P192,000
Ans.
P192,000
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 $50 million, calculate the dollar amount of
accounts receivable of this proposed change in credit policy. Assume a 360-day year
$3,817,445 decrease $6,500,000 decrease $3,333,334 decrease $18,749,778 increase
Ans.
$3,333,334 decrease
Wasting Resource Company has annual credit sales of P4 million. Its average collection period is 40 days,
and bad debts are 5% of sales. The credit and collection manager is considering instituting a stricter
collection policy, whereby bad debts would be reduced to 2% of total sales, and the average collection
period would fall to 30 days. However, sales would also fall by an estimated P500,000 annually. Variable
cost is 60% of sales and the cost of carrying receivables is 12%. Assuming a tax rate of 35% and 360 days
a year, the incremental change in the profitability of the company if stricter policy would be
implemented would be?
Zero as the positive and negative effects offset each other
A reduction in net income byP70,000
A reduction in net income by P38,350
A reduction in net income by P35,400
Ans.
A reduction in net income by P38,350
Dartmoor Company’s budgeted sales for the coming year are $40,500,000, of which 80% are expected to
be credit sales at terms of n/30. Dartmoor estimates that a proposed relaxation of credit standards will
increase credit sales by 20% and increase the average collection period from 30 days to 40 days. Based
on a 360 day year, the proposed relaxation of credit standards will result in an expected increase in the
average accounts receivable balance of? $540,000 $2,700,000 $900,000 $1,620,000
Ans.
$1,620,000
A change in credit policy has caused an increase in sales, an increase in discounts taken, a decrease in
the amount of bad debts, and a decrease in the investment in accounts receivable. Based upon this
information, the company’s
Average collection period has decreased
Percentage discount offered has decreased
Accounts receivable turnover has decreased
Working capital has increased
Ans.
Average collection period has decreased
A strict credit and collection policy is in place in Star Co. As Finance Director you are asked to advise on
the propriety of relaxing the credit standards in view of stiff competition in the market. Your advise will
be favorable if?
The competitor will do the same thing to prevent lost sales
there is a decrease in the distribution level of your product, and a more aggressive stance in necessary
to retain market share
The projected margin from increased sales will exceed the cost of carrying the incremental receivables
The account receivable level is improving, so the company can afford the carrying cost of receivables
Ans.
The projected margin from increased sales will exceed the cost of carrying the incremental receivables
Lawson Company has the opportunity to increase annual sales $100,000 by selling to a new group of
customers. Based on sales, the uncollectible expense is expected to be 15% and collection costs will be
5%. The company’s manufacturing and selling expenses are 70% of sales, and the effective tax rate is
40%. If Lawson accepts this opportunity, the company’s after tax profit will increase by?
$4,000 $6,000 $10,000 $9,000
Ans.
$6,000
Best Computers believes that its collection costs could be reduced through modification of collection
procedures. This action is expected to result in a lengthening of the average collection period from 28
days to 34 days; however, there will be no change in uncollectible accounts. The company’s budgeted
credit sales for the coming year are P27,000,000, and short-term interest rates are expected to average
8%. To make the changes in collection procedures cost beneficial, the minimum savings in collection
costs (using a 360-day year) for the year would have to be?
P 30,000 P360,000 P180,000 P 36,000
Ans.
P 36,000
An increase in sales resulting from an increased cash discount for prompt payment would be expected to
cause?
An increase in the operating cycle
An increase in the average collection period
A decrease in the cash conversion cycle
A decrease in purchase discounts taken
Ans.
A decrease in the cash conversion cycle
Prest Corporation plans to tighten its credit policy. Below is the summary of changes
Old
New
Average number of days collection
Ratio of credit to total sales
70%
75
60%
50
Projected sales for the coming year is P100 million and it was estimated that the new policy will be a 5%
less if the new policy is implemented. Assuming a 360-day year, what is the effect of the new policy on
accounts receivable?
Decrease of P13 million
No change
Decrease of P5 million
Decrease of P6,666,667
Ans.
Decrease of P6,666,667
The following information regarding a change in credit policy was assembled by the Wilson Wax
Company. The company has a required rate of return of 10% and a variable cost ratio of 60%.
Old Credit Policy
New Credit Policy
Sales $3,600,000
$3,960,000
Average collection period
30 days 36 days
The pretax cost of carrying the additional investment in receivables, using a 360-day year, would be
$5,760 $9,600 $8,160 $960
Ans.
$5,760
Slippers Mart has sales of P3 million. Its credit period and average collection period are both 30 days and
1% of its sales end up as bad debts. The general manager intends to extend the credit period to 45 days
which will increase sales by P300,000. However, bad debts losses on the incremental sales would be 3%.
Costs of products and related expenses amount to 40% exclusive of the cost carrying receivables of 15%
and bad debts expenses.
Assuming 360 days a year, the change in policy would result to incremental investments in receivables
of?
P24,704 P65,000 P162,500 P 9,750
Ans.
P162,500
A change in credit policy has caused an increase in sales, an increase in discounts taken, a reduction of
the investment in accounts receivable, and a reduction in the number of doubtful accounts. Based on
this information, we know that:
Net profit has increased
The average collection period has decreased
Gross profit has declined
The size of the discount offered has decreased
Ans.
The average collection period has decreased
Mr. S. Mart assumed the presidency of Riches Corp. He instituted new policies and with respect to credit
policy, below is a summary of relevant information:
Old Credit Policy
New Credit Policy
Sales P1,800,000
P1,980,000
Average collection period
30 days 36 days
The company requires a rate of return of 10% and a variable cost ratio of 60%. Using a 360-day year, the
pre-tax cost of carrying the additional investment in receivables under the new policy would be
P4,800 P2,880 P3,000 P4,080
Ans.
P2,880
Mr. S Mart assumed the presidency of Riches Corp. He instituted new policies with respect to credit
policy. Below is a summary of relevant information:
Credit policy
Old
New
Sales P1,800,000
P1,980,000
Average collection period
30 days 36 days
The company requires a rate of return of 10% and a variable cost ratio of 60%. Using a 360-day year, the
pre-tax cost of carrying the additional investment in receivables under the new policy would be?
P4,800,000 P2,880,000 P3,000,000 P4,080,000
Ans.
P2,880,000
A company with P4.8 million in credit sales per year plans to relax credit standards, projecting that this
will increase credit sales by P720,000. The company’s average collection period for new customers is
expected to be 75 days, and the payment behavior of the existing customers is not expected to change.
Variable costs are 80% of sales. The firm’s opportunity cost is 20% before taxes. Assuming a 360-day
year, what is the company’s benefit (loss) on the planned change in credit terms?
P
0 P28,800 P144,000 P120,000
Ans.
P120,000
Crest Company has the opportunity to increase annual sales by P1 million by selling to new riskier
customers. It has been estimated that uncollectible expenses would be 15% and collection costs, 5%. The
manufacturing and selling costs are 70% of sales and corporate tax is 35%. If they pursue this
opportunity, the after-tax profit will:
Increase by P35,000 Increase by P97,500 Increase by P65,000 Remain the same
Ans.
Increase by P65,000
Price Publishing is considering a change in its credit terms from n/30 to 2/10, n/30. The company’s
budgeted sales for the coming year are $24,000,000, of which 90% are expected to be made on credit. If
the new credit terms are adopted, Price estimates that discounts will be taken on 50% of the credit sales;
however, uncollectible accounts will be unchanged. The new credit terms will result in expected
discounts taken in the coming year of?
$216,000 $432,000 $240,000 $480,000
Ans.
$216,000
The Sales Director of Can Can Co. suggests that certain credit terms be modified. He estimates the
following effects:
·
Sales will increase by at least 20%.
·
Accounts receivable turnover will be reduced to 8 times from the present turnover of 10 times.
·
Bad debts, now at 1% of sales will increase to 1.5%.
·
Sales before the proposed changes is at P900,000. Variable cost ratio is 55% and desired rate of
return is 20%. Fixed expenses amount to P150,000.
Should the company allow the revision of its credit terms?
Yes, because income will increase by P64,800 (P68,850).
Yes, because losses will be reduced by P78,800
No, because income will be reduced by P13,000
No, because losses will increase by P28,000
Ans.
Yes, because income will increase by P64,800 (P68,850).
A firm sells on terms of 2/10 net 60. It sells 1,000 units per day at a unit price of $10. 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.)
Decrease by $4,000 Decrease by $40,000 Decrease by $240,000 Decrease by $280,000
Ans.
Decrease by $40,000
A company with $4.8 million in credit sales per year plans to relax its credit standards, projecting that
this will increase credit sales by $720,000. The average collection period for new customers is expected
to be 75 days, and the payment behavior of the existing customers is not expected to change. Variable
costs are 80% of sales. The firm’s opportunity cost is 20% before taxes. Assuming a 360-day year, what
is the company’s profit (loss) on the planned change in credit terms.
$0 $28,800 $144,000 $120,000
Ans.
$120,000
Crest Co. has the opportunity to increase annual sales by P1 million by selling to new riskier customers.
It has been estimated that uncollectible expenses would be 15% and collection costs 5%. The
manufacturing and selling costs are 70% of sales and corporate tax is 35%. If it pursues this opportunity,
the after tax profit will?
Increase by P35,000
Increase by P97,500
Increase by P65,000
Remain the same
Ans.
Increase by P65,000
Numero 1 Co.’s budgeted sales for the coming year are P96 million, of which 80% are expected to be
credit sales at terms of n/30. The company estimates that a proposed relaxation of credit standards
would increase credit sales by 30% and increase the average collection period form 30 days to 45 days.
Based on a 360-day year, the proposed relaxation of credit standards would result to an increase in
accounts receivable balance of?
P6,880,000 P1,920,000 P2,880,000 P6,080,000
Ans.
P6,080,000
Wasting Resource Co. has annual credit sales of P4 million. Its average collection period is 40 days and
bad debts are 5% of sales. The credit and collection manager is considering instituting a stricter
collection policy, whereby bad debts would be reduced to 2% of total sales, and the average collection
period would fall to 30 days. However, sales would also fall by an estimated P500,000 annually. Variable
costs are 60% of sales and the cost of carrying receivables is 12%. Assuming a tax rate of 35% and 360
days a year, the incremental change in the profitability of the company if stricter policy would be
implemented would be?
Zero as the positive and negative effects offset each other
A reduction in net income by P70,000
A reduction in net income by P38,35
A reduction in net income by P35,400
Ans.
A reduction in net income by P38,35
The sales manager at Ryan Company feels confident that, if the credit policy at Ryan’s were changed,
sales would increase and, consequently, the company would utilize excess capacity. The two credit
proposals being considered are as follows:
Proposal A
Proposal B
Increase in sales
$ 500,000
$ 600,000
Contribution margin
20%
20%
Bad debt percentage 5%
5%
Increase in operating profits
$ 75,000
$ 90,000
Desired return on sales 15%
15%
Currently, payments terms are net 30. The proposed payment terms for Proposal A and Proposal B are
net 45 and net 90, respectively. An analysis to compare these two proposals for the change in credit
policy would include all of the following factors except the
Cost of funds for Ryan
Current bad debt experience
Impact on the current customer base of extending terms to only certain customers
Bank loan covenants on days’ sales outstanding
Ans.
Current bad debt experience
The company sells 10,000 units at a unit selling price of 66 annually. Assume that the average collection
period is 25 days. After the credit policy is well established, what is the expected average accounts
receivable balance for the company at any moment in time, assuming a 365-day year?
684.93 1,808.22 27,123.30 45,205.48
Ans.
45,205.48
The credit and collection policy of Amargo Co. provides for the imposition of credit block when the credit
line is exceeded and/or the account is past due. During the month, because of the campaign to achieve
volume targets, the general manager has waived the credit block policy in a number of instances
involving big volume accounts. The likely effect of this move.
Deterioration of aging of receivables only
Increase in the level of receivables only
Deterioration of aging and increase in the level of receivables
Decrease in collections during the month the move was done
Ans.
Deterioration of aging and increase in the level of receivables
The sales manager of Ryan Company feels confident that, if the credit policy at Ryan’s were changed,
sales would increase and, consequently, the company would utilize excess capacity. The two credit
proposals being considered are as follows:
Proposal A
Proposal B
Increase in sales
P 500,000
P 600,000
Contribution margin
20% 20%
Bad debts percentage 5%
5%
Increase in operating profits
P 75,000
P 90,000
Desired return on sales 15%
15%
Currently, payment terms are net 30. The proposed payment terms for Proposal A and Proposal B are
net 45 and net 90, respectively. An analysis to compare these two proposals for the change in credit
policy would include all of the following factors except the:
Cost of funds for Ryan
Current bad debt experience
Impact on the current customer base of extending terms to only certain customers
Bank loan covenants on days’ sales outstanding
Ans.
Current bad debt experience
Slippers Mart has sales of P3 million. Its credit period and average collection period are both 30 days
and 1% of its sales end as bad debts. The general manager intends to extend the credit period to 45
days which will increase sales by P300,000. However, bad debts losses on the incremental sales would
be 3%. Costs of products and related expenses amount to 40% exclusive of the cost of carrying
receivables of 15% and bad debts expenses. Assuming 360 days a year, the change in policy would result
to incremental investment in receivables of?
P24,704 P65,000 P701,573 P9,750
Ans.
P65,000
Hakuna Mutata Inc. sells on terms of 3/10 net 30 days. Gross sales for the year are P2,400,000 and the
collection department estimates that 30 percent of the customers pay on the tenth day and take
discounts; 40 percent pay on the thirtieth day; and the remaining 30 percent pay, on the average, 40
days after the purchase. Assuming 360 days per year, what is the average collection period?
40 days. 15 days. 20 days. 27 days.
Ans.
27 days.
Simba Corporation whose gross sales amounted to P1,200,000 sold on terms of 3/10, net 30. The
collections manager estimated that 30 percent of the customers pay on the tenth day and take
discounts; 40 percent on the thirtieth days; and the remaining 30 percent pay, on the average, 40 days
after the purchase. If management would toughen on its collection policy and require that all nondiscount customers pay on the thirtieth day, how much would be the receivables balance?
P50,000 P80,000 P70,000 Zero
Ans.
P80,000
Jackson Distributors sells to retail stores on credit terms of 2/10, net 30. Daily sales average 150 units at
a price of P300 each. Assuming that all sales are on credit and 60% of customers take the discount and
pay on day 10 while the rest of the customers pay on day 30, the amount of Jackson’s accounts
receivable is
P1,350,000 P 990,000 P 900,000 P 810,000
Ans.
P 810,000
The official terms of purchases of U Tang & Company are 2/10, net/30 but generally the company does
not pay until 40 days after the invoice date. The purchases total P3,600,000 per year. Assuming 360 days
a year, the approximate cost of the non-free trade credit amounts to?
18.36% 24.50% 21.90% 19.40%
Ans.
24.50%
ABC Company finances all of its seasonal inventory needs from the local bank at an effective interest cost
of 9%. The firm’s supplier promises to extend trade credit on terms that will match the 9% bank credit
rate. What terms would the supplier have to offer (approximately)?
2/10, n/60 2/10, n/100 2/10, n/90 3/10, n/60
Ans.
2/10, n/90
Garo Company, retail store, is considering foregoing sales discounts in order to delay using its cash.
Supplier credit terms are 2/10, net 30. Assuming a 360-day year, what is the annual cost of credit if the
cash discount is not taken and Garo pays net 30?
24.0% 24.5% 36.0% 36.7%
Ans.
36.7%
When a company offers credit terms of 2/10, net 30, the annual interest cost, based on a 360-day year,
is?
24.0% 35.3% 36.0%. 36.7%.
Ans.
36.7%.
If a firm purchases raw materials from its suppliers on a 2/10, n/60 cash discount basis, the equivalent
annual interest rate (using a 360-day year) of foregoing the cash discount and making payment on the
60th days is?
36.7% 14.7% 73.5% 12.2%
Ans.
14.7%
Bachoy & Co. buys on terms 2/10, net 30, but generally does not pay until 40 days after the invoice date.
Its purchases total P2,160,000 per year. Assuming 360 days a year, the amount of “non-free” trade credit
used by the company on the average each year is?
P180,000 P240,000 P60,000 P120,000
Ans.
P180,000
Accounts receivable management is concerned with:
I.
Policies related to the recognition of accounts receivable.
II.
Policies related to the collection of accounts receivable.
Both I and II I only II only Neither I or II
Ans.
Both I and II
The high-cost of short-term financing has recently caused a company to reevaluate the terms of credit it
extends to its customers. The current policy is 1/10, net 60. If customers can borrow at prime rate, at
what prime rate must the company change its terms of credit in order to avoid an undesirable extension
in its collection of receivables?
2% 5% 7% 8%
Ans.
8%
Using a 360-day year, what is the opportunity cost to a buyer of not accepting terms 3/10, net 45?
55.67% 31.81% 22.27% 101.73%
Ans.
31.81%
If a firm purchases raw materials from its suppliers on a 2/10, n/60 cash discount basis, the equivalent
annual interest rate (using a 360-day year) of foregoing the cash discount and making payment on the
60th day is?
36.7% 14.7% 73.5% 12.2%
Ans.
14.7%
Three suppliers of Mama Corporation offer different credit term. Core Co. offers term of 1 ½ /15, net 30.
Doug Corp. offers terms of 1/10, net 30. Ernst Inc. offers of 2/10, net 60. Mama Corporation would have
to borrow from a bank at an annual rate of 12% in order to take any cash discounts. Which one of the
following would be the most attractive for Ma Corp.? (Assume 360 days a year.)
Purchase from Core Co., pay in 15 days and borrow any money needed from the bank
Purchase from Core Co., pay in 30 days and borrow any money needed the bank
Purchase from Ernst Inc., pay in 60 days and borrow any money needed from the bank
Purchase from Doug Corp and pay in 30 days
Ans.
Purchase from Core Co., pay in 15 days and borrow any money needed from the bank
CyberAge Outlet, a relatively new store, is a café that offers customers the opportunity to browse the
internet or play computer games at their tables while they drink and dine. The customer pays a fee
based on the amount of time spent signed on to the computer. The store also sells books, tee-shirts, and
computer accessories. CyberAge paying all of is bills on the last day of the payment period, thus
forfeiting all supplier discounts. Shown below are data on CyberAge’s two major vendors, including
average monthly purchases and credit terms.
Vendor Average Monthly Purchases
Credit Terms
Webmaster
$25,000
2/10, net 30
Softidee
50,0005/10, net 90
Should CyberAge use trade credit and continue paying at the end of the credit period?
Yes, if the cost of alternative short-term financing is less
Yes, if the firm’s weighted-average cost of capital is equal to its weighted-average cost of trade credit
No, if the cost of alternative long-term financing is greater
Yes, if the cost of alternative short-term financing is greater
Ans.
Yes, if the cost of alternative short-term financing is greater
Mamimili, Inc. purchased an item on credit with terms of 3/10, n/45. Based on a 360-day year, the
company’s annual interest cost of foregoing the cash discount and making payment on the last day of
the credit period is?
12.2% 8.7% 6.4% 6.2%
Ans.
8.7%
An organization would usually offer credit terms of 2/10, net 30 when?
The organization can borrow funds at a rate exceeding the annual interest cost
The organization can borrow funds at a rate less than the annual interest cost
The cost of capital approaches the prime rate
Most competitors are offering the same terms and the organization has a shortage of cash
Ans.
Most competitors are offering the same terms and the organization has a shortage of cash
Merkle, Inc. has a temporary need for funds. Management is trying to decide between not taking
discounts from one of their three biggest suppliers, or a 14.75% per annum renewable discount loan
from its bank for 3 months. The suppliers' terms are as follows:
Fort Co.1/10, net 30
Riley Manufacturing Co. 2/15, net 60
Shad, Inc.
3/15, net 90
Using a 360-day year, the cheapest source of short-term financing in this situation is?
The bank Fort Co Riley Manufacturing Co Shad, Inc
Ans.
Shad, Inc
CyberAge Outlet, a relatively new store, is a café that offers customers the opportunity to browse the
internet or play computer games at their tables while they drink and dine. The customer pays a fee
based on the amount of time spent signed on to the computer. The store also sells books, tee-shirts, and
computer accessories. CyberAge paying all of is bills on the last day of the payment period, thus
forfeiting all supplier discounts. Shown below are data on CyberAge’s two major vendors, including
average monthly purchases and credit terms.
Vendor Average Monthly Purchases
Credit Terms
Webmaster
$25,000
2/10, net 30
Softidee
50,0005/10, net 90
[i]. Assuming a 360-day year and the CyberAge continues paying on the last day of the credit period,
the company’s weighted-average annual interest rate on trade credit (ignoring the effects of
compounding) on these two vendors is
________________________________________
27.0% 25.2% 28.0% 30.2%
Ans.
25.2%
CyberAge Outlet, a relatively new store, is a cafe that offers customers the opportunity to browse the
internet or play computer games at their tables while they drink coffee. The customer pays a fee based
on the amount of time spent signed on to the computer. The store also sells books, tee shirts, and
computer accessories. CyberAge has been paying all of its bills on the last day of the payment period,
thus forfeiting all supplier discounts. Shown below are data on CyberAge’s two major vendors, including
average monthly purchases and credit terms.
Vendor Average Monthly Purchases
Credit Terms
Web Master
P25,000
2/10, net/30
Softidee
50,000 5/10, net/90
Assuming a 360-day and that CyberAge continues paying on the last day of the credit period, the
company’s weighted average annual interest rate for trade credit (ignoring the effects of compounding)
for these two vendors is?
27.0% 25.2% 28.0% 30.2%
Ans.
25.2%
Batchoy & Company buys on terms 2/10, net 30, but generally does not pay until 40 days after the
invoice date. Its purchases total P2,160,000 per year. Assuming 360 days a year, the amount of “nonfree” trade credit used by the company on the average.
P180,000 P240,000 P 60,000 P120,000
Ans.
P180,000
Mamimili, Inc. purchased an item on credit with terms of 3/10 net 45. Based on a 360-day year, the
company’s annual interest cost of foregoing the cash discounts and making payment on the last day of
the credit period is:
24.00 % 31.81% 24.74% 30.86%
Ans.
31.81%
Buddah Corporation intends to acquire a new equipment to increase its capacity. It is estimated to cost
P2.4 million. A bank loan can finance the acquisition at ten percent (10%) discounted interest.
Alternatively, the company may adjust 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. Assuming 360 days a year, the company should?
Borrow since it is cheaper by 1.13% than delaying payment to suppliers
Borrow since it is cheaper by 2.5% than delaying payment to suppliers
Delay payments to suppliers since it would cost 12% as against bank loan of 10%.
Delay payments to suppliers since it does not cost anything
Ans.
Borrow since it is cheaper by 1.13% than delaying payment to suppliers
The official terms of purchases of U Tang & Co. are 2/10, net 30 but generally the company does not pay
until 40 days after the invoice date. Its purchases total P3,600,000 per year. Assuming 360 days a year,
the approximate cost of the “non-free trade credit amounts to?
18.36% 24.50% 21.90% 19.40%
Ans.
24.50%
Three suppliers of Ma Corp. offer different credit terms. Core Co. offers terms of 1½ /15, net 30. Doug
Corp. offers terms of 1/10, net 30. Ernst Inc. offers terms of 2/10, net 60. Ma Corp. would have to
borrow from a bank at an annual rate of 12% in order to take any cash discounts. Which one of the
following would be the most attractive for Ma Corp. (Assume 360 days a year.).
Purchase from Core Co., pay in 15 days and borrow any money needed from the bank
Purchase from Core Co. pay in 30 days and borrow any money needed from the bank
Purchase from Ernst Inc., pay in 60 days and borrow any money needed from the bank
Purchase from Doug Corp. and pay in 30 days
Ans.
Purchase from Core Co., pay in 15 days and borrow any money needed from the bank
Moe's Boat Service currently does not offer a discount to encourage its customers to pay early for
services provided to them. Moe has discussed with his accountant the possibility of offering a 2%
discount to improve its cash conversion cycle. Moe's accountant determined the following:
Credit sales expected to remain unchanged at P1,000,000
The 2% discount is expected to be taken on 40% of accounts receivable balance amounts.
The average accounts receivable would likely decrease by P30,000
Moe has an opportunity cost of 15% associated with its use of cash.
Which one of the following is the peso amount of net benefit or cost that Moe would obtain if the
proposed 2% discount plan is implemented?
P3,500 P4,500 P8,000 P20,000
Ans.
P3,500
Assuming a 360-day year, the nominal rate for foregoing discount from the credit term 210, n/30 is?
36% 2.04% 2% 36.73%
Ans.
36.73%
On cash discounts, all of the following statements do not apply except:
If a firm buys P10,000 of goods on terms of 1/10, net 30 and pays within the discount period, the
amount paid would be P9,000
The cost of not taking a cash discount is always higher than the cost of a bank loan
With trade terms of 2/15, net 60, if the discount is taken the buyer receives 45 days of free credit The
cost of not taking the discount is higher for terms of 2/10, net 60 than for 2/10, net 30
Ans.
With trade terms of 2/15, net 60, if the discount is taken the buyer receives 45 days of free credit
Regal Corporation purchased an item on credit with terms 3/10, n/45. Using a 360 day year, the
company’s annual interest cost of foregoing the cash discount and making payment on the last day of
the credit period is?
30.93% 31.81% 24.74% 30.86%
Ans.
31.81%
Which one of the following would not be considered a carrying cost associated with inventory?
Insurance costs.
Cost of capital invested in the inventory.
Cost of obsolescence.
Shipping costs.
Ans.
Shipping costs.
Identify the following statements as true or false.
Statement 1 – The primary role of the accountant in inventory management is deciding which Inventory
to buy and how much to buy.
Statement 2 – The economic order quantity model may be used to determine the optimum time to
acquire inventory.
Statement 1
True
False
True
False
Ans.
False
Statement 2
True
False
False
True
False
Blonde Company’s budgeted sales and budgeted cost of sales for the coming year are P14.4 million and
P9 million, respectively. Short-term interest rates are expected to average 15%. If the company can
increase inventory turnover form its present level of nine times a year to a level times a year, its cost
savings in the coming year would be
P60,000 P67,500 P90,000 P37,500
Ans.
P37,500
Indicate whether the following statements are true or false.
Statement 1 – The cost of warehousing and storage, property taxes, insurance of inventory, losses from
spoilage are examples of ordering costs.
Statement 2 – One of the relevant costs in inventory management is “carrying cost” which refers to the
total effect of the failure of a company to service customers or conduct manufacturing operations
smoothly because goods, raw materials and/or suppliers are out of stock.
Statement 1
Statement 2
True
False
True
False
True
False
Ans.
False
False
True
False
In assessing the loan value of inventory, a banker will normally be concerned about the portion of
inventory that is work-in-process because?
WIP inventory is relatively easy to sell because it does not represent a raw materials or a finished
product.
WIP inventory usually has the highest loan value of the different inventory types.
WIP generally has the lowest marketability of the various types of inventories.
WIP represents lower investments by a corporation as opposed to other types of inventories.
Ans.
WIP generally has the lowest marketability of the various types of inventories.
The inventory technique that identifies the determination of the lead time quantity upon which the next
order should have punctually placed:
Safety stock quantity
Economic order quantity
Materials requirements planning
Red-line technique
Ans.
Red-line technique
In the two-bin system, the quantity in the second bin is equal to the:
EOQ ROP Lead time quantity Optimal safety stock
Ans.
Lead time quantity
Jeff Company sells 20,000 radios evenly throughout the year. The cost of carrying one unit of inventory
for one year is P8, and the purchase order cost per order is P32. What is the economic order quantity?
200 400 283 625
Ans.
400
The carrying cost associated with inventory management includes
Insurance cost, shipping costs, storage costs, and obsolescence.
Storage costs, handling costs, interest on capital invested, and obsolescence.
Purchasing cost, shipping costs, set up costs, and quantity discount lost.
Obsolescence, set up costs, interest on capital invested, and purchasing order costs.
Ans.
Storage costs, handling costs, interest on capital invested, and obsolescence.
Karpov Enterprises, a wholesaler of electronic instruments, uses the economic order quantity model in
its inventory management. Data concerning one product appear below:
Total units purchased annually 810
Costs to place one order
$10
Selling price per unit $40
Annual cost to carry one unit in stock $ 2
The economic order quantity (EOQ) for this product would be:
18 units. 90 units. 81 units. 180 units.
Ans.
90 units.
The carrying cost pertaining to inventory includes:
Insurance costs, incoming freight costs and storage costs
Insurance costs, incoming freight costs and setup costs
Setup costs and opportunity cost of capital invested in inventory
Storage costs and opportunity cost of capital invested in inventory
Ans.
Storage costs and opportunity cost of capital invested in inventory
If one optimizes the inventory turnover ratio, which costs will not increase?
Total reorder costs Stockout costs Unit reorder costs Carrying costs
Ans.
Carrying costs
The economic order quantity (EOQ) formula can be adapted in order for a firm to determine the optimal
mix between cash and marketable securities. The EOQ model assumes all of the following except that:
The cost of a transaction is independent of the peso amount of the transaction and interest rates are
constant over the short run
An opportunity cost is associated with holding cash, beginning with the first peso
The total demand for cash is known with certainty
Cash flow requirements are random
Ans.
Cash flow requirements are random
Which of the following inventory management approaches seeks to minimize total inventory costs by
considering both the restocking (reordering) cost and carrying costs?
Economic order quantity. Just-in-time Materials requirements planning ABC
Ans.
Economic order quantity.
The order costs associated with inventory management include?
Insurance cost, purchasing costs, shipping costs, and obsolescence
Obsolescence, set up costs, quantity discounts lost, and storage costs
Quantity discounts lost, storage costs, handling costs, and interest on capital invested
Purchasing costs, shipping costs, setup costs, and quantity discounts lost
Ans.
Purchasing costs, shipping costs, setup costs, and quantity discounts lost
Which one of the following would not be considered a carrying cost associated with inventory?
Insurance costs
Cost of capital invested in the inventory
Cost of obsolescence
Shipping costs
Ans.
Shipping costs
One of the products Nature Health Products sells is a magnetic back support. The ordering costs related
to this product is P12.50 per order. The cost of carrying one item of inventory for one year is P16.00.
The business sells 40,000 of this type of product evenly throughout the year. How much is the total
ordering costs per year and total carrying costs per year at the economic order quantity?
P1,562.50
P1,562.50
P1,562.50
P2,560.00
P2,000.00
P2,000.00
P4,000.00
P4,000.00
Ans.
P4,000.00
P4,000.00
Order-filling costs, as opposed to order-getting costs, include all but which of the following items?
Credit check of new customs
Packing and shipping of sales order
Collection of payments for sales order
Mailing catalogs to current customer
Ans.
Mailing catalogs to current customer
The economic order quantity (EOQ) will rise following?
A decrease in annual unit sales
An increase in carrying costs
An increase in the per-unit purchased price of inventory
An increase in the variable costs of placing and receiving an order
Ans.
An increase in the variable costs of placing and receiving an order
The production department of a manufacturing company has been plagued with excessive number of
defective units of standards machine parts that are purchased from vendors on a regular basis. The most
relevant quantitative management technique for designing a formal inspection system for incoming parts
is:
Economic order quantity models
Regression analysis
Statistical quality control
Standard cost variance analysis
Ans.
Statistical quality control
You computed the economic order quantity of the main raw material of Moonlight Company at 10,000
units. However, the chief purchasing officer decided to order in quantities of 12,000 units. What is the
probable effect of this decision on the company’s annual purchase order cost compared with those
amounts had the order been made at the economic order quantity?
Lower purchase order cost and higher carrying cost
Lower purchase order cost and lower carrying cost.
Higher purchase order cost and lower carrying cost
Higher purchase order cost and higher carrying cost
Ans.
Lower purchase order cost and higher carrying cost
Ryerson Computer Furniture Inc. (RCF) manufactures a line of office chairs. The annual demand for the
chairs is 5,000 units. The annual cost to carry one chair in inventory is $10 and the cost to set up a
production run is $1,000. There are no chairs on hand in inventory, and RCF management has scheduled
four production runs of chairs for the coming year, the first of which is to be run immediately. A total of
1,250 chairs will be produced in each of the production runs. RCF has 250 business days per year and
sales occur uniformly throughout the year.
The number of production runs per year that would minimize the sum of the inventory carrying costs
and set-up costs for the coming year is:
1 production run.
2 production runs.
4 production runs.
5 production runs.
Ans.
5 production runs.
In computing the economic order quantity (EOQ), which of the following costs should be included?
The shipping cost to deliver the products to the customer
Capital cost
Purchasing staff’s salaries
Expected value analysis
Ans.
Capital cost
A manufacturing company dates invoices seasonally so that skis delivered in September will bear an
invoice due date for the following February. As a result of using this method, the manufacturer’s
inventory carrying costs are (lower; higher; constant) and the buyer is extended to a (shorter; longer)
credit period than would otherwise be true.
Lower, longer Higher, longer Lower, shorter Higher, shorter
Ans.
Higher, longer
Politan Company manufactures 4,000 bookcases a year. Set-up costs are $20 for a production run. Using
the economic order quantity (EOQ) approach, the optimal production lot size would be 200 units when
the cost of carrying one bookcase in inventory for one year is:
$0.50. $1.00. $2.00. $4.00.
Ans.
$4.00.
An increase in inventory carrying cost will ?
Decrease the economic order quantity
Increase the safety stock required
Have no effect on the economic order quantity
Decrease the number of orders issued per year
Ans.
Decrease the economic order quantity
State whether the following statements are true or false.
Statement 1-The two main types of inventory cost relevant to inventory decision-making are carrying
costs and ordering costs.
Statement 2-The optimal ordering quantity in the EOQ model occurs at the point where the sum of the
carrying costs and ordering costs are minimized.
False
True
False
True
Ans.
True
Statement 1
True
False
False
True
Statement 2
True
Rodentstock, Inc., currently places orders for a particular stock item at quarterly intervals. Information
concerning these items is as follows:
Cost of placing an order P10
Annual demand 20,000 units
Purchasing price per unit
P1.00
Carrying cost rate
10%
What annual cost saving would result if Rodentstock used the economic order quantity for order sizes
instead of their current policy?
P80 P90 P150 P240
Ans.
P90
A characteristics of the basic economic order quantity (EOQ) model is that is?
Is relatively insensitive to error
Should not be used when carrying cost are large in relation to procurement cost
Is used when product demand, lead-time, and order costs are uncertain
Should not be used in conjunction with computerized perpetual inventory system
Ans.
Is relatively insensitive to error
Missile Company has correctly computed its economic order quantity as 500 units. However,
management feels it would rather order in quantities of 600 units. How should Missile’s total annual
purchase-order costs and total annual carrying cost for an order quantity of 600 units compare to the
respective amounts for an order quantity of 500 units?
Lower purchase-order cost and lower carrying cost
Higher purchase-order cost and higher carrying cost
Lower purchase-order cost and higher carrying cost
Higher purchase –order cost and lower carrying cost
Ans.
Lower purchase-order cost and higher carrying cost
The selling price of the product is relatively high and the purchase cost of the product is relatively low. In
this situation:
Management must increase the price to cover the cost of carrying higher inventory
The EOQ model will indicate frequent larger orders
The EOQ of the product is affected by the selling price
The selling price has nothing to do with the EOQ of the product
Ans.
The selling price has nothing to do with the EOQ of the product
The Stewart Company uses the economic order quantity (EOQ) model for inventory management. A
decrease in which one of the following variables would increase the EOQ?
Annual sales
Cost per order
Safety stock level
Carrying costs
Ans.
Carrying costs
Cantor Creations, which has 250 business days per year, manufactures desks for desktop workstations.
The annual demand for the desks is estimated to be 5,000 units. The annual cost of carrying one unit in
inventory is $10, and the cost to set up a production run is $1,000. Cantor has scheduled four equal
production runs for the coming year, the first to begin immediately. Currently, there are no desks on
hand. Assume that sales occur uniformly throughout the year and that production is instantaneous.
If Cantor Creations were to schedule only two equal production runs of the desks for the coming year,
the sum of carrying costs and set-up costs would increase (decrease) by:
$4,250.
$(2,000)
. $6,250.
$(250).
Ans.
$4,250.
As a consequence of finding a more dependable supplier and adopting just-in-time inventory ordering,
Dee Co. reduced its safety stock of raw materials inventory by 80%. Which one of the following would
the reduction in safety stock have on Dee’s economic order quantity?
80% decrease
64% decrease
20% increase
0% change (no effect)
Ans.
0% change (no effect)
The Aron Company requires 40,000 units of Product Q for the year. The units will be used evenly
throughout the year. It costs $60 to place an order. It costs $10 to carry a unit in inventory for the year.
What is the economic order quantity (EOQ) rounded to the nearest whole unit?
400.
490.
600.
693.
Ans.
693.
The simple economic production lot size model will only apply to situation in which the production?
Rate equals the demand rate
Rate is less than the demand rate
Rate is greater than the demand rate
For the period covered equals the projected sales for the period
Ans.
Rate is greater than the demand rate
Which of the following will not affect the budgeting of order-getting costs?
Market research and test
Location of distribution warehouses
Policies and action of competitors
Sales promotion policies
Ans.
Location of distribution warehouses
Moss Converters Inc. uses 100,000 kilograms of raw material annually in its production processes. The
raw material costs $12 per kilogram. The cost to process a purchase order is $45, which includes variable
costs of $35 and allocated fixed costs of $10. Out-of-pocket storage costs are $4.20 per kilogram per year.
Moss's economic order quantity (EOQ) is:
1,291 units. 1,464 units. 1,708 units. 1,936 units.
Ans.
1,291 units.
The order size determined by the economic order quantity formula minimizes the annual inventory cost
which is comprised of ordering costs and
Safety stock cost Carrying cost Stock out cost No answer
Ans.
Carrying cost
With regards to inventory management, an increase in the frequency of ordering will normally?
Reduce the total cost
Have no impact on ordering costs
Reduce the total carrying costs
Have no impact of total carrying costs
Ans.
Reduce the total carrying costs
The economic order quantity (EOQ) formula assumes that?
Purchase costs per unit differ because of quantity discounts
Costs of placing an order vary with quantity order
Periodic demand for the good is known
Erratic usage rates are cushioned by safety stocks
Ans.
Periodic demand for the good is known
Economic order quantity models and two-bin system are commonly used controls for a company’s
materials function. Those controls primarily relate to what part of the cycle?
Materials Requirements Raw Materials acceptance Physical storage Product distribution
Ans.
Materials Requirements
Softdrinks Distributors, which buys in a pre-sell basis, is discussing with the route salesmen on the
proper cases to be ordered and the frequency of call. From the route book and other records, the
following are available: prior year’s purchases, 50,000 cases; carrying cost per case of inventory, P1.20;
distributor’s discount, 1 case for every 10 cases bought; cost of placing an order, P3.00; weekly demand
is approx. 952 cases. Safety stock required is 140 cases. No change in demand is expected this year. (Use
a 365-day, 52-week year). Determine the economic order quantity (EOQ), and the reorder point
assuming a two-day lead-time. EOQ is 482 cases; reorder point is 500 cases
EOQ is 500 cases; reorder point is 414 cases
EOQ is 962 cases; reorder point is 275 cases
EOQ is 250 cases; reorder point is 280 cases
Ans.
EOQ is 500 cases; reorder point is 414 cases
Ryerson Computer Furniture Inc. (RCF) manufactures a line of office chairs. The annual demand for the
chairs is 5,000 units. The annual cost to carry one chair in inventory is $10 and the cost to set up a
production run is $1,000. There are no chairs on hand in inventory, and RCF management has scheduled
four production runs of chairs for the coming year, the first of which is to be run immediately. A total of
1,250 chairs will be produced in each of the production runs. RCF has 250 business days per year and
sales occur uniformly throughout the year.
If RCF does not maintain a safety stock, the estimated total inventory carrying costs for the chairs for the
coming year based on their current production schedule is:
CMA adapted
$4,000. $5,000. $6,250. $12,500.
Ans.
$6,250.
In inventory management, the problem of avoiding excessive investment in inventories and at the same
time avoiding inventory shortages can be solved by applying a quantitative technique known as?
Payback analysis
Probability analysis
Economic order quantity model
High-low point method
Ans.
Economic order quantity model
The economic order quantity is the size of the order that minimizes total inventory costs, including
ordering and carrying costs. If the annual demand decreases by 36%, the optimal order size will?
Decrease by 20%. Increase by 20%. Increase by 6%. Decrease by 6%.
Ans.
Decrease by 20%.
The result of the economic order quantity formula indicates the?
Annual quantity of inventory to be carried
Annual usage of materials during the year
Safety stock plus estimated inventory for the year
Quantity of each individual order during the year
Ans.
Quantity of each individual order during the year
DF Tires Unlimited is a business enterprise located in the city of Cagayan de Oro. The market price on a
per unit basis is P3,000. Since Cagayan de Oro is a very progressive rural place, the business sells an
average of 36,000 tires annually. Based on a company study covering the last five years of its operations,
it was found out that annual carrying cost per tire is P5.00 and the ordering cost is P100 on a per order
basis. The store is open 7 days a week (which includes Sundays and holidays of obligation). The delivery
time per order (tires are ordered from Manila) is 5 days. Since it normally takes time before an order is
placed, filled up and delivered, the manager has decided to keep a safety stock of 3,000 tires which is
equivalent to a month’s sales. The average inventory is?
3,493 tires 3,600 tires 1,200 tires 3,000 tires
Ans.
3,600 tires
The following data relate to a part used by the Henry Company:
Units required per year 30,000
Cost of placing an order $ 400
Unit carrying cost per year
$ 600
Assuming that the units will be used evenly throughout the year, what is the economic order quantity
(EOQ)?
200. 300. 400. 500.
Ans.
200.
The amount of inventory that a company would tend to hold in stock would increase as the?
Sales level fails to permanently lower level
Cost of carrying inventory decreases
Variability of sales decreases
Cost of carrying out of stock decreases
Ans.
Cost of carrying inventory decreases
Identify the following statements as true or false.
Statement 1 – EOQ is the quantity that would minimize the total relevant annual
inventory carrying cost.
Statement 2 – The increasing computerization of the inventory control system
promises to eradicate completely the need for the use of human judgment in
inventory control.
Statement 1
True , True
Ans.
True ,
Statement 2
False , False
False , True
True ,
False
False
In the Economic Order Quantity (EOQ) model, some of the underlying assumptions are:
Unlimited production capacity, declining demand, decreasing ordering cost,
decreasing carrying cost, and unlimited inventory capacity.
Constant demand, constant ordering cost, constant carrying cost, unlimited production and
inventory capacity.
Limited production capacity, declining demand, constant ordering cost, constant
carrying cost, and unlimited inventory capacity.
Increasing demand, limited production capacity, increasing ordering cost, increasing
carrying cost, and limited inventory capacity.
Ans.
Constant demand, constant ordering cost, constant carrying cost, unlimited production and inventory
capacity.
The Stewart Company uses the Economic Order Quantity (EOQ) model in its inventory
management. A decrease in which of the following variables would increase the
company's EOQ?
Annual sales.
Cost per order.
Safety stock level.
Inventory carrying costs.
Ans.
Inventory carrying costs.
A decrease in inventory order costs will?
Decrease the economic order quantity
Increase the reorder point
Have no effect on the economic order quantity
Decrease the carrying cost percentage
Ans.
Decrease the economic order quantity
One of the elements included in the economic order quantity (EOQ) formula is?
Safety stock
Ans.
Yearly demand
Selling price of item
Lead time for delivery
Yearly demand
Marlita works for a local ceramic company. She just completed her accountancy degree and
learned the EOQ model in one of her subjects. She suggested to her employer to adopt it. The
company sells 20,000 pieces of specialty ceramic items each year. Traditionally they have
produced these items four times a year, making 5,000 pieces at a time. They carry no safety
stock, as customers do not mind waiting for orders. The average piece of ceramic items cost P400
to make and costs the company P20 to carry in inventory for a year. The set up costs for each
production run total P80. The company should?
Adopt EOQ due to savings of P35,675
Continue the existing system due to P38,950 advantage
Adopt EOQ due to savings of P42,320
Continue the existing system due to P41,820 advantage
Ans.
Adopt EOQ due to savings of P42,320
An increase in inventory holding costs will?
Have no effect on the economic order quantity
Increase the economic order quantity
Decrease the number of orders issued per year
Decrease the economic order quantity
Ans.
Decrease the economic order quantity
Which one of the following items is not directly reflected in the basic economic order quantity
(EOQ) model?
interest on invested capital
Public warehouse rental charges
Setup costs of manufacturing runs
Quantity discounts lost on inventory purchases
Ans.
Quantity discounts lost on inventory purchases
Based on an EOQ analysis (assuming a constant demand), the optimal order quantity is 2,500.
The company desires a safety stock of 500 units. A 5-day lead-time is needed for delivery.
Annual inventory carrying costs equal 25% of the average inventory level. The company pays P4
per unit to buy the product, which it sells for P8. The company pays P150 to place a detailed
order, and the monthly demand for the product is 4,000 units. Total inventory order per year
equal.
P1,250
Ans.
P2,880
P2,400
P2,880
P3,600
The following information are given with respect to product Cute of Smile Corporation in 2018:
Optimal production run in units
2,000
Average inventory in units
1,000
Number of production runs
5
Cost per unit production
Desired annual
investment
return
P75
on
inventory
Set-up cost per production run
18%
P5,000
If the units will required evenly throughout the year, the total annual relevant costs using the economic-order-quantity
approach is:
P 5,000
P 75,000
P 50,000
P150,000
Ans.
P 50,000
Felix Company sells 200 units of discs per week. Purchase order lead-time is 3 weeks and the
economic order quantity is 450 units. What is the reorder point?
425 units.
Ans.
600 units.
1,750 units.
600 units.
2,250 units.
Cantor Creations, which has 250 business days per year, manufactures desks for desktop
workstations. The annual demand for the desks is estimated to be 5,000 units. The annual
cost of carrying one unit in inventory is $10, and the cost to set up a production run is
$1,000. Cantor has scheduled four equal production runs for the coming year, the first to
begin immediately. Currently, there are no desks on hand. Assume that sales occur
uniformly throughout the year and that production is instantaneous.
Huron Corporation should reorder headbands when the quantity in inventory reaches:
5,000 units.
Ans.
6,750 units.
1,750 units.
5,250 units.
6,750 units.
Felix Company sells 200 units of discs per week. Purchase order lead-time is 3 weeks and
the economic order quantity is 450 units. What is the reorder point?
425 units.
Ans.
1,750 units.
600 units.
2,250 units.
600 units.
Arnold Enterprises uses the EOQ model for inventory control. The company has an annual
demand of 50,000 units for part number 191 and has computed an optimal lot size of 6,250 units.
Per-unit carrying costs and stockout costs are P13 and P3, respectively. The following costs
data have been gathered in an attempt to determine an appropriate safety stock level:
Units Short Because of
Excess Demand during
Number of Times
The Lead Time Period
Short in the Last 40
Reorder Cycles
200
6
300
12
400
6
The annual cost of establishing a 200-unit safety stock is expected to be?
P2,600
Ans.
P4,040
P4,040
P4,260
P5,200
Huron Corporation purchases 60,000 headbands per year. The average purchase lead-time is 20
working days, safety stock equals 7 days normal usage, and the corporation works 240 dayd per
year. Huron should reorder headbands when the quantity in inventory reaches.
5,000 units
Ans.
6,750 units
6,750 units
1,750 units
5,250 units
Felix Company sells 200 units of discs per week. Purchase order lead-time is 3 weeks and
the economic order quantity is 450 units. What is the reorder point?
425 units
Ans.
600 units
1,750 units
600 units
2,250 units
The economic order quantity (EOQ) in an inventory management system is:
the order quantity that yields the lowest unit purchase cost.
the order quantity that yields the lowest inventory handling cost.
the order quantity that yields the lowest total cost of ordering and carrying inventory.
the order quantity with the largest purchase discount.
Ans.
the order quantity that yields the lowest total cost of ordering and carrying inventory.
A company experiences both variable usage rates and variable lead times for its inventory
items. The probability distributions for both usage and lead times are known. A technique
the company could use for determining the optimal safety stocks levels for an inventory
items is
Queuing theory.
Linear programming
Decision tree analysis.
Monte Carlo simulation.
Ans.
Monte Carlo simulation.
M & L Company has the following information on inventory:
Sales
20,000 units per year
Order quantity
4,000 units
Safety stock
2,600 units
Lead-time
4 weeks
What is the re-order point? (For calculation purposes, use 50-week year)
4,200 units.
Ans.
2,600 units.
5,600 units.
2,600 units.
1,600 units.
The China Tee Store sells 100,000 tea bags a year. Additional data are presented below:
1.
Selling price per bag
2.
Purchase cost per bag
3.
Ordering cost:
4.
Carrying cost:
5.
Number of days the company operates in a year: 250
6.
Average lead time on purchases: 6 days
What is the reorder point if the company will keep a 10-day safety stock of inventory?
2,400 bags
Ans.
5,400 bags
6,400 bags
8,800 bags
6,400 bags
For inventory management, ignoring safety stocks, which of the following is a valid computation
of the reorder point?
The economic order quantity
The economic order quantity times the anticipated demand during lead-time
The anticipated demand per day during lead-time times lead-time in days
The square root of the anticipated demand during the lead-time
Ans.
The anticipated demand per day during lead-time times lead-time in days
Discs Unlimited sells 200 discs per week. Purchase order lead-time averages three weeks. Based
on most updated calculation, the economic order quantity is 450 units. The reorder point is?
600 discs
425 discs
1,750 discs
2,250 discs
Ans.
600 discs
The elapsed time between placing an order for inventory and receiving the order is?
Lead time
Ans.
Reorder time
Stockout time
Stocking time
P2.50
P1.50
P5.40 an
20% of u
Lead time
D & R Corporation consumes 300,000 units of spare part V per year. The average purchase leadtime is 20 working days while maximum is 27 working days. The company’s annual operations
cover 240 days allowing for shutdowns for plant maintenance, holidays and Sundays. The
company would like to keep safety stock or extra stock to guard against stock outs. How much is
the safety stock?
25,000 units
1,250 units
33,750 units
8,750 units
Ans.
1,250 units
When a specified level of safety stock is carried for an item in inventory, the average inventory
level for that item is?
Decreases by the amount of the safety stock
Is one-half level of the safety stocks
Increases by one-half the amount of the safety stock
Increases by the amount of the safety stock
Ans.
Increases by the amount of the safety stock
Handy operated a chain of hardware stores across Laguna. The controller wants to
determine the optimum safety stock levels for an air purifier unit. The inventory
manager compiled the following data.
•
The annual carrying cost of inventory approximates 20% of the investment in
inventory.
•
The inventory investment per unit averages P50.
•
The stockout cost is estimated to be P5 per unit.
•
The company orders inventory on the average of 10 times per year.
•
Total cost = carrying cost + expected stockout cost.
•
The probabilities of a stockout per order cycle with varying levels of safety
stock are as follows:
Safety
Stock
200
100
0
Units
Stockout
Probability
0
100
200
0%
15%
12%
The total cost of safety stock on an annual basis with a safety stock level of 100 units
is?
P1,750
Ans.
P1,950
P 550
P2,000
P1,750
Cantor Creations, which has 250 business days per year, manufactures desks for desktop
workstations. The annual demand for the desks is estimated to be 5,000 units. The annual
cost of carrying one unit in inventory is $10, and the cost to set up a production run is
$1,000. Cantor has scheduled four equal production runs for the coming year, the first to
begin immediately. Currently, there are no desks on hand. Assume that sales occur
uniformly throughout the year and that production is instantaneous.
A safety stock of a five-day supply of desks would increase the number of units in Cantor
Creations' planned average inventory by:
50 units.
Ans.
100 units.
250 units.
500 units.
100 units.
Each stockout of Product AX sold by Axiom Inc. costs P8,750 per occurrence. The
carrying cost per unit of inventory is P250 per year, and the company orders 1,500 units
of product 24 times a year at a cost of P5,000 per order. The probability of stockout at
various levels of safety stock is:
Units of
safety stock
0
100
200
300
400
0 unit
Ans.
Probability of
stockout
.50
.30
.14
.05
.01
100 units
200 units
The optimal safety stock level for the company is?
300 units
200 units
Canesco Enterprises uses 84,000 units of Part 256 in its production over a 300-day work
year. The usual lead time for delivery of the part from the supplier is six days;
occasionally, the lead time has been as high as eight days. The company wants to
implement a safety stock policy (it presently carries no safety stocks). The safety stock
size, the likely effect on stockout costs of implementing the safety stock, and the likely
effect on carrying costs of implementing the safety stock, respectively, would be:
560 units, decrease, increase.
560 units, increase, decrease.
1,680 units, decrease, increase.
1,680 units, increase, no change.
Ans.
560 units, decrease, increase.
What are the three factors a manager should consider in controlling stockouts?
Carrying costs, quality costs, and physical inventories
Economic order quantity, annual demand, and quality costs
Time needed for delivery, rate of inventory usage, and safety stock
Economic order quantity, production bottlenecks, and safety stock
Ans.
Time needed for delivery, rate of inventory usage, and safety stock
A company stocks, maintains, and distributes inventory. The company decides to add of the
safety stock and expedite delivery for several product lines on a trial basis. For the selected
product lines, the company will experience.
An increase in some costs but no change in the service level
A change in the service level
An increase in ordering, carrying, and delivery costs
A decrease in ordering, carrying, and delivery costs
Ans.
A change in the service level
When a specific level of stock is carried for an item in inventory, the average inventory level for
that item is?
Is not affected by the safety stock
Increase by the amount of the safety stock
Increase by the one-half the amount of the safety stock
Decrease by the amount of the safety stock
Ans.
Increase by the amount of the safety stock
For a 300-day work year Kulasa Corp. consumes 420,000 units of an inventory item. The usual lead-time for the inventory
item is six (6) days; however, at times, the lead-time has gone high as eight (8) days. Kulasa now desires to adjust its safety
stock policy. The likely effect on stockout costs and carrying costs, respectively, would be?
Increase and decrease
Decrease and decrease
Increase and increase
Decrease and increase
Ans.
Decrease and increase
Canesco Enterprises uses 84,000 units of Part 256 in its production over a 300-day work
year. The usual lead time for delivery of the part from the supplier is six days;
occasionally, the lead time has been as high as eight days. The company wants to
implement a safety stock policy (it presently carries no safety stocks). The safety stock
size, the likely effect on stockout costs of implementing the safety stock, and the likely
effect on carrying costs of implementing the safety stock, respectively, would be:
The level of safety stock depends on all of the following except:
the level of uncertainty of the sales forecast.
the level of customer dissatisfaction when goods are unavailable.
the level of uncertainty in the lead time for shipments from suppliers.
the ordering cost per order.
Ans.
the ordering cost per order.
When the level of safety stock is increased?
Lead time will increase
The frequency of stockouts will decrease
Carrying costs will decrease
Order costs will decrease
Ans.
The frequency of stockouts will decrease
Cantor Creations, which has 250 business days per year, manufactures desks for desktop
workstations. The annual demand for the desks is estimated to be 5,000 units. The annual
cost of carrying one unit in inventory is $10, and the cost to set up a production run is
$1,000. Cantor has scheduled four equal production runs for the coming year, the first to
begin immediately. Currently, there are no desks on hand. Assume that sales occur
uniformly throughout the year and that production is instantaneous.
The Huron Corporation purchases 60,000 headbands per year. The average purchase lead
time is 20 working days. Maximum lead time is 27 working days. The corporation works
240 days per year.
Horun Corporation should carry a safety stock of:
5,000 units.
Ans.
6,750 units
1,750 units.
5,250 units.
1,750 units.
Ryerson Computer Furniture Inc. (RCF) manufactures a line of office chairs. The annual
demand for the chairs is 5,000 units. The annual cost to carry one chair in inventory is
$10 and the cost to set up a production run is $1,000. There are no chairs on hand in
inventory, and RCF management has scheduled four production runs of chairs for the
coming year, the first of which is to be run immediately. A total of 1,250 chairs will be
produced in each of the production runs. RCF has 250 business days per year and sales
occur uniformly throughout the year.
A safety stock of a five-day supply of computer chairs would increase RCF's planned
average inventory by:
20 units.
Ans.
5 units.
100 units.
50 units.
100 units.
Eklog Manufacturing Corporation uses the standard economic order quantity (EOQ) model. If
the EOQ for Product A is 200 units and Eklog maintains a 50-unit safety stock for the item, what
is the average inventory of Product A?
250 units
Ans.
150 units
150 units
125 units
100 units
Scholas Company uses 840,000 units of component R4 in manufacturing P444 over a
300-day work year. The usual lead-time for the part is six days, however at times, the
lead time has gone high as eight days. Scholas now desires to adjust its safety stock
policy. The increase in safety stock size is:
6,800 units
Ans.
2,800 units
7,200 units
5,600 units
5,600 units
Jasper Inc. produces automobile headlight assemblies for sports-utility vehicles. Data concerning a particular metal fastener
that is used in a one of the company's products appear below.
Economic order quantity
Average weekly usage
Maximum weekly usage
Lead time
600 units
150 units
175 units
2 weeks
The safety stock would be:
350 units.
Ans.
50 units.
175 units.
50 units.
75 units.
As a consequence of finding a more dependable supplier, Dee Company reduced its safety stock
of raw materials by 80%. What is the effect of this safety stock reduction on Dee’s economic
order quantity?
80% decrease
64% decrease
20% increase
No effect
Ans.
No effect
In inventory management, the safety stock will tend to increase if the?
Carrying cost increases
Cost of running out of stock decreases
Variability of the lead time increases
Fixed order cost decreases
Ans.
Variability of the lead time increases
The costs of stock-out do not include:
Depreciation and obsolescence
Loss of customer goodwill
Loss of sales
Disruption of production schedules
Ans.
Depreciation and obsolescence
Cantor Creations, which has 250 business days per year, manufactures desks for desktop
workstations. The annual demand for the desks is estimated to be 5,000 units. The annual
cost of carrying one unit in inventory is $10, and the cost to set up a production run is
$1,000. Cantor has scheduled four equal production runs for the coming year, the first to
begin immediately. Currently, there are no desks on hand. Assume that sales occur
uniformly throughout the year and that production is instantaneous.
If Cantor Creations does not maintain a safety stock, the estimated total carrying costs for
the desks for the coming year is:
$5,000.
Ans.
$6,250.
$4,000.
$10,250.
$6,250.
Traditionally, large manufactures have believed that economics of scale gained through large
production runs of like, or similar, products are the best way to keep production costs down and
remain competitive. Select the most appropriate response to whether this theory is still valid.
Yes, larger economics of scale continues to accrue from ever larger production runs
Yes, lower-per-unit costs for standard products continue to guarantee a competitive advantage
No, economics of scale can no longer be gained from long production runs
No, production flexibility and diversity of products are needed to remain competitive
Ans.
No, production flexibility and diversity of products are needed to remain competitive
The underlying philosophy of “just-in-time” inventory system is
That the status of quantities on hand must be periodically reviewed where high-value or
critical items are examined more frequently than low-cost or non-critical items
It is a quest toward continuous improvement in the environmental conditions that
necessitate inventories
That the quantities of most stock are subject to definable limits
That it is impractical to give equal attention to all stock items, hence the need to
classify and rank them according to their cost significance
Ans.
It is a quest toward continuous improvement in the environmental conditions that necessitate
inventories
Which one of the following is not a characteristic of a just-in-time inventory system?
Reducing distance and time between related production operations
Establishing close, long-term relationships with suppliers
Decreasing the number of deliveries from suppliers
Reducing raw material safety stock
Ans.
Decreasing the number of deliveries from suppliers
In inventory control system which employs mathematical models as an aid in making inventory
decisions is known as?
Order cycling system
Two-bin system
Statistical inventory control systems
Mini-max system
Ans.
Statistical inventory control systems
Which one of the following is not considered a modern inventory management technique?
Economic order quantity
Materials requirements planning
Just in time inventory system
Theory of constraints
Ans.
Economic order quantity
The inventory model that follows the concept that 80% of the value of an inventory is in 20% of
the inventory items is the?
ABC system
Economic order quantity (EOQ) model
Just-in-time inventory system
Materials requirements planning (MRP) system
Ans.
ABC system
The prime lending rate of commercial banks is an announced rate and is often understated from
the viewpoint of even the most credit-worthy firms. Which one of the following requirements
always results in a higher effective interest rate?
A floating rate for the loan period.
A covenant that restricts the issuance of any new unsecured bonds during the existence of the
loan.
The imposition of a compensating balance with an absolute minimum that cannot be met by
current transaction balances.
The absence of a charge for any unused portion in the line of credit.
Ans.
The imposition of a compensating balance with an absolute minimum that cannot be met by
current transaction balances.
A temporary increase in merchandise inventory to meet a seasonal demand would best
be financed by:
An increase in current liabilities.
Issuing bonds.
Issuing preferred stock.
Issuing common stock.
Ans.
An increase in current liabilities.
Following the hedging principle of financing, short-term liabilities would appropriately be used
to finance which one of the following?
The acquisition of plant machinery.
The payment of bond principal at maturity.
An opportunity to acquire inventory at a bargain price.
The acquisition of a patent.
Ans.
An opportunity to acquire inventory at a bargain price.
Which one of the following statements about trade credit is correct? Trade credit is
Not an important source of financing for small firms.
A source of long-term financing to the seller.
Subject to risk of buyer default.
Usually an inexpensive source of external financing.
Ans.
Subject to risk of buyer default.
Nexco, Inc. is considering factoring its accounts receivable. Factorco, Inc. has offered
the following terms for accounts receivable due in 30 days:
Value of receivables to be held in reserve for contingencies
Following costs are deducted at time accounts are factored:
Interest rate on amounts provided
Factor fee on total receivables factored
10%
12%
2%
If Nexco factors P200,000 of its accounts receivable due in 30 days with Factorco and,
during that 30 days, P10,000 of those accounts receivable are reversed because the related
goods were return or allowances were granted, which one of the following is the amount
that Nexco will receive from Factorco at the end of the 30-day period?
P0-(no amount)
Ans.
P9,800
P10,000
P19,600
P10,000
The principal advantage of using commercial paper as a short-term financing instrument is that
it
Is usually cheaper than a commercial bank loan.
Is readily available to almost all companies.
Offers security, i.e., collateral, to the lender.
Can be purchased without commission costs.
Ans.
Is usually cheaper than a commercial bank loan.
Which one of the following provides a spontaneous source of financing for a firm?
Accounts payable.
Ans.
Mortgage bonds.
Accounts receivable.
Debentures.
Accounts payable.
A company obtaining short-term financing with trade credit will pay a higher percentage
financing cost, everything else being equal, when
The discount percentage is lower.
The items purchased have a higher price.
The items purchased have a lower price.
The supplier offers a longer discount period.
Ans.
The supplier offers a longer discount period.
A company is arranging debt financing for the purchase of a new piece of equipment that has a 5year expected useful life. Which of the following alternative financing arrangements has the
lowest effective annual percentage rate if each has a quoted nominal rate of 9.5%?
term loan with interest compounded annually.
A 5-year
A 10-year term loan with interest compounded semiannually.
A 5-year term loan with interest compounded quarterly.
A 10-year term loan with interest compounded monthly.
Ans.
A 5-year term loan with interest compounded annually.
Which one of the following responses is not an advantage to a corporation that uses the
commercial paper market for short-term financing?
This market provides more funds at lower rates than other methods provides.
The
borrower avoids the expense of maintaining a compensating balance with a commercial
bank.
There are no restrictions as to the type of corporation that can enter into this market.
This market provides a broad distribution for borrowing.
Ans.
This market provides a broad distribution for borrowing.
Short-term securities issued by the Federal Housing Administration are known as
Agency securities.
Bankers' acceptances.
Commercial paper.
Repurchase agreements.
Ans.
Agency securities.
Which of the following uses of accounts receivable, if either, would be considered
short-term financing?
Pledging Accounts
Factoring Account
Receivable
Receivable
Yes
Yes
Yes
No
No
Yes
No
Ans.
No
Yes
Yes
Asher Company eased its credit policy by lengthening its discount period from 10
days to 15 days. Which of the following is/are likely reasons for Asher lengthening its
discount period?
I.
To show a higher average age of accounts on its accounts receivable aging
schedule.
II.
To meet terms offered by competitors.
III.
To seek to stimulate sales.
I only.
Ans.
II only.
III only.
II and III only.
II and III only.
Which of the following statements concerning shirt-term financing is/are correct?
I. Accounts payable can provide short-term financing.
II. Accounts receivable can provide short-term financing.
III. Inventory can provide short-term financing.
I only.
Ans.
I and II, only.
I and III, only.
I, II, and III.
An example of secured short-term financing is
Commercial paper.
A warehouse receipt.
A revolving credit agreement.
I, II, and III.
Line of credit.
Ans.
A warehouse receipt.
A small retail business would most likely finance its merchandise inventory with
Commercial paper.
A terminal warehouse receipt loan.
A line of credit.
A chattel mortgage.
Ans.
A line of credit.
A company will receive cash from sales in 1 year that can be used to pay for
materials. The supplier will allow payment in 1 year. If the company pays the supplier
immediately, it will receive a 20% discount off the $100,000 purchase price, but it
must borrow the full amount. A bank has offered the company three alternatives:
1. A 1-year loan at 18% with no other fees,
2. A 1-year loan at 15% with the provision that it maintains 20% of whatever
amount it borrows as noninterest-bearing compensating balances over the life of
the loan, or
3.
A guaranteed line of credit of $100,000 at 17% with the provision that the bank
will collect a 1% fee on the average amount of unused funds. The company expects to
borrow no other funds.The company would achieve the lowest cost of financing by
Allowing the supplier to finance the materials and making payment at the end of 1
year.
Accepting the 1-year loan at 18% with no other provisions.
Accepting the 1-year loan at 15% with the compensating balance provisions.
Accepting the guaranteed line of credit at 17% with the fee required on the average
amount of unused funds.
Ans.
Accepting the guaranteed line of credit at 17% with the fee required on the average amount of
unused funds.
A manufacturing firm wants to obtain a short-term loan and has approached several
lending institutions. All of the potential lenders are offering the same nominal interest
rate, but the terms of the loans vary. Which of the following combinations of loan terms
will be most attractive for the borrowing firm?
Simple interest, no compensating balance.
Discount interest, no compensating balance.
Simple interest, 20% compensating balance required.
Discount interest, 20% compensating balance required.
Ans.
Simple interest, no compensating balance.
An example of secured short-term financing is
Commercial paper.
A warehouse receipt.
A revolving credit agreement.
Line of credit.
Ans.
A warehouse receipt.
Nexco, Inc. is considering factoring its accounts receivable. Factorco, Inc. has offered
the following terms for accounts receivable due in 30 days:
Value of receivables to be held in reserve for contingencies
10%
Following costs are deducted at time accounts are factored:
Interest rate on amounts provided before deducting interest (annual rate) 12%
Factor fee on total receivables factored
2%
If Nexco plans to factor P200,000 of accounts receivable due in 30 days, which one of the
following is the amount it will receive from Factorco at the time the accounts are
factored?
P154,880
Ans.
P174,240
P176,000
P196,000
P174,240
Which one of the following financial instruments generally provides the largest source of shortterm credit for small firms?
Installment loans.
Ans.
Trade credit.
Commercial paper.
Trade credit.
Mortgage bonds.
The credit instrument known as a banker's acceptance
Calls for immediate payment upon delivery of the shipping documents to the bank's
customer and acceptance of goods by the bank.
Involves an invoice being signed by the banker upon receipt of goods, after which
both the banker and the seller record the transaction on their respective books.
Is a time draft payable on a specified date and guaranteed by the bank.
Is a method of sales financing in which the bank retains title to the goods until the buyer
has completed payment.
Ans.
Is a time draft payable on a specified date and guaranteed by the bank.
Po Co. plans to use its inventory as collateral for a short-term loan. Which one of the following
types of loan agreements with its lender would provide Po Co. the most flexibility in the use of
the inventory it pledges as collateral?
Field warehouse agreement.
Floating lien agreement.
Chattel mortgage agreement.
Terminal warehouse agreement.
Ans.
Floating lien agreement.
On January 23, Inco Company received from one of its suppliers a statement with terms of "2/10,
n/30." Because the statement was misfiled, it was not located for payment until February 5. On
which one of the following dates should the bill be paid?
February 5.
Ans.
February 22.
February 6.
February 22.
February 28.
Which of the following wrongful acts prevents recovery under a policy of fire insurance?
Arson by the insured's employees or agents
Arson by third persons unrelated to the insured
An act by the insured intended to cause the damage
Gross negligence but not amounting to recklessness and willful misconduct.
Ans.
An act by the insured intended to cause the damage
When the risks of the individual components of a project’s cash flows are different, an acceptable
procedure to evaluate these cash flows is to?
Divide each cash flows by the payback period.
Compute the net present value of each cash flow using firm’s cost of capital.
Compare the internal rate of return from each cash flow to its risk.
Discount each cash flow using a discount rate that reflects the degree of risk.
Ans.
Discount each cash flow using a discount rate that reflects the degree of risk.
The degree of operating leverage (DOL) is?
A measure of the change in earnings available to common stockholders associated with a
given change in operating earnings.
A measure of the change in operating income resulting from a given change in sales.
Lower if the degree of total leverage is higher, other things held constant.
Higher if the degree of total leverage is lower, other things held constant.
Ans.
A measure of the change in operating income resulting from a given change in sales.
Company specific risk is also known as which one of the following?
Market-related risk
Business risk
Unsystematic risk
Non diversifiable risk
Ans.
Unsystematic risk
The risk of loss because of fluctuations in the relative value of foreign currencies is called?
Expropriation risk
Ans.
Exchange rate risk
Sovereign risk
Multinational beta.
Exchange rate risk
CPA 0588 L-59
On April 2, 1999, Ritz Corp. purchased a warehouse that it insured for $500,000. The
policy contained a 75% coinsurance clause. On April 25, 2000, a fire caused $900,000
damage to the warehouse. The fair market value of the warehouse was $800,000 on April
2, 1999 and $1 million on April 25, 2000. Ritz is entitled to receive insurance proceeds
of, at most?
$375,000
Ans.
$500,000
$600,000
$750,000
$500,000
Which of the following wrongful acts prevents recovery under a policy of fire insurance?
Arson by the insured's employees or agents.
Arson by third persons unrelated to the insured.
An act by the insured intended to cause the damage.
Gross negligence but not amounting to recklessness and willful misconduct.
Ans.
An act by the insured intended to cause the damage.
CMA 0690 1-15
In general, it is more expensive for a company to finance with equity capital than with
debt capital because?
Long-term bonds have a maturity date and must therefore be repaid in the future.
Investors are exposed to greater risk with equity capital
Equity capital is in greater demand than debt capital.
Dividends fluctuate to a greater extent than interest rates.
Ans.
Investors are exposed to greater risk with equity capital
Mason Co. maintained two standard fire insurance policies on one of its warehouses. Both
policies included an 80% coinsurance clause and a typical "other insurance" clause. One policy
was with Ace Fire Insurance, Inc., for P24,000, and the other was withThrifty Casualty Insurance
Co., for P16,000. At a time when the warehouse was worth P100,000, a fire in the warehouse
caused a P40,000 loss. What amounts can Mason recover from Ace and Thrifty, respectively?
P0 and P0
P10,000 and P10,000
Ans.
P12,000 and P8,000
P12,000 and P8,000
P24,000 and P16,000
O & B Company, a U.S. corporation, is in possession of accounts receivable denominated in
German deutsche marks. To what type of risk are they exposed?
Liquidity risk
Ans.
Exchange-rate risk.
Business risk
Exchange-rate risk.
Price risk.
The upward sloping yield curve shown implies that the
Credit risk premium of corporate bonds has increased.
Credit risk premium of municipal bonds has increased.
Long-term interest rates have a higher annualized yield than short-term rates.
Short-term interest rates have a higher annualized yield than long-term rates.
Ans.
Long-term interest rates have a higher annualized yield than short-term rates.
Components of long-term financing would be part of?
Capital
Financial
Structure
Financing
Yes
Yes
Yes
No
No
Yes
No
No
Yes
Yes
Ans.
A building that originally cost $60,000 is now worth $200,000. The owner holds a $120,000 fire
insurance policy with an 80% co-insurance clause. If a fire causes $150,000 of damage to the
structure, how much will the owner be able to collect from the insurance company?
$112,500
Ans.
$112,500
$120,000
$150,000
$160,000
Which of the following is the best functional definition of insurance?
A legal contract by which the insurer, in return for consideration, agrees to pay another
person if a stated loss or injury occurs.
A legal contract by which an insurance company, in return for premiums, agrees to pay the
policyholder if a certain event occurs.
A written promise by the insurer to pay the beneficiary if loss occurs from the occurrence of
a contingent event.
A writing issued by an insurance company, for a consideration, that promises to indemnify a
beneficiary for a loss from an existing risk or one which arises later.
Ans.
A legal contract by which the insurer, in return for consideration, agrees to pay another person if
a stated loss or injury occurs.
When purchasing temporary investments, which one of the following best describes the
risk associated with the ability to sell the investment in a short period of time without
significant price concessions?
Interest rate risk.
Ans.
Purchasing power risk.
Financial risk
Liquidity risk.
Liquidity risk.
Life insurance is?
Is a contract of indemnity
Usually has short-term policies.
Covers only the mortality risk
Generally has no cash value.Life insurance is a contract for the payment of a specified
amount to the named beneficiary or to the estate of the insured if the insured dies while the
policy is in effect. Payment for the actual loss is called indemnity. Hence, life insurance is a
contract of indemnity.
Ans.
Is a contract of indemnity
Short-term interest rates are?
Usually lower than long-term rates.
Usually higher than long-term rates.
Lower than long-term rates during periods of high inflation only.
Not significantly related to long-term rates.
Ans.
Usually lower than long-term rates.
Which of the following long-term notes would best facilitate financial leverage for the
borrowing firm?
Variable Rate
Long-Term
Note
Ans.
Fixed Rate
LongTerm Note
Yes
Yes
Yes
No
No
Yes
No
No
No
Yes
CMA 1291 1-4
A firm's financial risk is a function of how it manages and maintains its debt. Which one
of the following sets of ratios characterizes the firm with the greatest amount of financial
risk?
High debt-to-equity ratio, high interest-coverage ratio, volatile return on equity
High debt-to-equity ratio, high interest-coverage ratio, stable return on equity.
Low debt-to-equity ratio, low interest-coverage ratio, volatile return on equity
High debt-to-equity ratio, low interest-coverage ratio, volatile return on equity
Ans.
Low debt-to-equity ratio, low interest-coverage ratio, volatile return on equity
Which of the following is a characteristic of fire insurance?
It is more standardized than life insurance.
It is written for a relatively short period but usually includes an incontestability clause.
policy must be valued and contain a pro rata clause.
The insurable interest must be an ownership interest in the property itself.Fire insurance is
the most standardized kind of insurance. Following the lead of New York, almost all states have
enacted a standard policy either by legislative or administrative action.
Ans.
It is more standardized than life insurance.
A downward-sloping yield curve depicting the term structure of interest rates implies that?
Interest rates have declined over recent years.
Interest rates have increased over recent years.
Prevailing short-term interest rates are lower than prevailing long-term interest rates.
Prevailing short-term interest rates are higher than prevailing long-term interest rates.
Ans.
Prevailing short-term interest rates are higher than prevailing long-term interest rates.
which of the following is not a type of insurance policy that provides liability insurance?
A
Malpractice insurance
Homeowners insurance
Automobile insurance
Fire insurance
Ans.
Fire insurance
CIA 0589 IV-49
Which of the following classes of securities are listed in order from lowest
risk/opportunity for return to highest risk/opportunity for return?
U.S. Treasury bonds; corporate first mortgage bonds; corporate income bonds;
preferred stock.
Corporate income bonds; corporate mortgage bonds; convertible preferred stock;
subordinated debentures.
Common stock; corporate first mortgage bonds; corporate second mortgage bonds;
corporate income bonds.
Preferred stock; common stock; corporate mortgage bonds; corporate debentures.
Ans.
U.S. Treasury bonds; corporate first mortgage bonds; corporate income bonds; preferred stock.
CMA 0689 1-8
Which one of the following statements is correct regarding the effect preferred stock has
on a company?
The firm's after-tax profits are shared equally by common and preferred
shareholders.
Control of the firm is now shared by the common and preferred shareholders, with
preferred shareholders having greater control.
Preferred shareholders' claims take precedence over the claims of common
shareholders in the event of liquidation.
Nonpayment of preferred dividends places the firm in default, as does nonpayment of
interest on debt.
Ans.
Preferred shareholders' claims take precedence over the claims of common shareholders in the
event of liquidation.
Pod bought a building in 1996 for P220,000. At that time, Pod purchased a P150,000 fire
insurance policy with Owners Insurance Co. and a P50,000 fire insurance policy with
Group Insurance Corp. Each policy contained a standard 80% coinsurance clause. In
2000, when the building had a fair market value of P250,000, it was damaged in a fire.
How much would Pod recover from Owners and Group if the fire totally destroyed the
building?
P160,000
Ans.
P200,000
P220,000
P250,000
P200,000
CMA 0695 1-1
A firm with a higher degree of operating leverage when compared to the industry average
implies that the?
Firm has higher variable costs
Firm's profits are more sensitive to changes in sales volume
Firm is more profitable
Firm is less risky
Ans.
Firm's profits are more sensitive to changes in sales volume
Business risk excludes such factors as?
Financial risk
Amount of operating leverage
Demand variability
Fluctuations in suppliers' prices
Ans.
Financial risk
Insurance may best be defined as?
A system for transferring risk through risk avoidance or loss control
Any contract that conveys an insurable interest
A form of pure risk called gambling.
A means of combining many loss exposures so that losses are shared by all participants.
Ans.
A means of combining many loss exposures so that losses are shared by all participants.
Jewelry, Inc. took out an insurance policy with Insurance Company which covered the stock of
jewelry. Insurance agreed to indemnify for losses due to theft of the jewels displayed. The
application contained the following provision: "It is hereby warranted that the maximum value of
the jewelry displayed shall not exceed P10,000." The insurance policy's coverage was for P8,000.
Subsequently, thieves smashed the store window and stole P4,000 worth of jewels when the total
value of the display was P12,000. Which of the following is correct?
recover nothing.
Jewelry, Inc. will
Jewelry, Inc. will recover P2,000, the loss less the amount in excess of the P10,000 display
limitation.
Jewelry, Inc. will recover the full P4,000 since the warranty will be construed as a mere
representation.
Jewelry, Inc. will recover the full P4,000 since attaching the application to the policy is
insufficient to make it a part thereof.
Ans.
Jewelry, Inc. will recover nothing.
Life insurance.
Is a contract of indemnity
Usually has short-term policies
Covers only the mortality risk
Generally has no cash value
Ans.
Is a contract of indemnity
Which one of the following identifies the rate of return required by investors to compensate them
for deferring current consumption when making an investment?
Prime rate
Ans.
Risk-free rate
Risk-free rate
Discount rate
Effective rate
Which of the following statements concerning the use of short-term financing by an
entity is/are correct?
I.
Short-term financing generally offers greater financial flexibility than longterm financing.
II.
Short-term financing generally has a lower interest rate than long-term
financing.
III.
Short-term financing generally has a lower risk of liquidity than long-term
financing.
I only is correct
I and II are correct
II and III are correct
I, II, and III are correct
Ans.
I and II are correct
Which one of the following named risks cannot be mitigated through diversification of
investments?
Unsystematic risk
Ans.
Systematic risk
Systematic risk
Firm-specific risk
Company unique risk
CIA 1194 IV-14
If Company A has a higher rate of return on assets than Company B, this could be
because Company A has a <List A> profit margin on sales, or a <List B> asset turnover
ratio, or both.
List A
List
B
Higher
Higher
Higher
Lower
Lower
Higher
Lower
Lower
Higher
Higher
Ans.
CPA 1192 L-56
Hart owned a building with a fair market value of $400,000. The building was covered by
a $300,000 fire insurance policy containing an 80% coinsurance clause. What amount
would Hart recover if a fire totally destroyed the building?
$0
Ans.
$240,000
$300,000
$400,000
$300,000
Everything else being equal, a <List A> highly leveraged firm will have <List B>
earnings per share.
List A
List List
B
More
Lower
More
Less
volatile
Less
Less
volatile
Less
Higher
Less
Less
volatile
Ans.
CMA 0693 1-5
The term "underwriting spread" refers to the?
Commission percentage an investment banker receives for underwriting a security
issue.
Discount investment bankers receive on securities they purchase from the issuing
company.
Difference between the price the investment banker pays for a new security issue and
the price at which the securities are resold.
Commission a broker receives for either buying or selling a security on behalf of an
investor.
Ans.
Difference between the price the investment banker pays for a new security issue and the price at
which the securities are resold.
Jon Berstock is an employee of PR, Inc. During his employment, the corporation's earnings have
doubled, largely because of Jon' s ability to attract new accounts. PR therefore insured his life for
a substantial sum. If Jon dies, will PR be able to collect the insurance proceeds?
Yes, because a corporation has an insurable interest in all its employees
Yes, because PR has an insurable interest in Jon's continued life.
No, because PR will continue to exist after Jon's death
No, because Jon was not a shareholder or officer of PR, Inc
Ans.
Yes, because PR has an insurable interest in Jon's continued life.
A U.S. company currently has domestic operations only. It is considering an equalsize investment in either Canada or Britain. The data on expected rate of return and
the risk associated with each of these proposed investments are given below.
Proposed Investment
Mean Return
Standard
Deviation
British Investment
22%
10%
Canadian Investment
28%
15%
The mean return on the company's current (domestic only) business is 20%, with a
standard deviation of 15%. Using the above data and the correlation coefficients, the
company calculated the following portfolio risk and return (based on a ratio of
50% U.S. domestic operations and 50% international operations).
Investments
Mean Return
Standard Deviation
U.S. and Britain
21%
3%
U.S. and Canada
24%
15%
The company plans to select the optimal combination of countries based on risk and
return for the domestic and international investments taken together. Based on the above
data, which one of the following alternatives provides the best risk adjusted return to the
firm?
Undertake the British investment.
Undertake the Canadian investment.
Do not undertake either investment.
Unable to determine based on data given.
Ans.
Undertake the British investment.
CIA 1196 IV-53
All else being equal, a company with a higher dividend-payout ratio will have a <List A>
debt-to-assets ratio and a <List B> current ratio.
List
A
List
B
Higher
Higher
Higher
Lower
Lower
Higher
Lower
Lower
Higher
Lower
Ans.
Short-term financing is normally concerned with financing for which one of the following
lengths of time?
Length of the operating cycle
Length of the collection cycle
One year or less in length
Up to 10 years in length
Ans.
One year or less in length
The type of risk that is not diversifiable and affects the value of a portfolio is?
Purchasing-power risk.
Market risk.
Nonmarket risk
Interest-rate risk
Ans.
Market risk.
CIA 0592 IV-49
The level of risk that concerns investors who supply capital to a diversified company is?
Project risk (beta).
Pure play risk (beta).
The weighted average of project risk (betas).
Accounting risk (beta).
Ans.
The weighted average of project risk (betas).
Business risk excludes such factors as?
Financial risk
Amount of operating leverage
Demand variability
Fluctuations in suppliers' prices.
Ans.
Financial risk
Sensitivity analysis, if used with capital projects,:
Is used extensively when cash flows are known with certainly.
Measures the change in the discounted cash flows when using the discounted payback
method rather than the net present value method.
Is a “what-if” technique that asks how a given outcome will change if the original estimates
of the capital budgeting model are changed.
Is a technique used to rank capital expenditure requests.
Ans.
Is a “what-if” technique that asks how a given outcome will change if the original estimates of
the capital budgeting model are changed.
Life insurance is offered in several forms. The kind that offers no investment feature is?
Whole life
Ans.
Term.
Endowment.
Straight life
Term.
A higher degree of operating leverage compared with the industry average implies that the firm?
Has higher variable costs.
Has profits that are more sensitive to changes in sales volume.
Is more profitable
Is less risky
Ans.
Has profits that are more sensitive to changes in sales volume.
On April 2, 1999, Ritz Corp. purchased a warehouse that it insured for P500,000. The policy
contained a 75% coinsurance clause. On April 25, 2000, a fire caused P900,000 damage to the
warehouse. The fair market value of the warehouse was P800,000 on April 2, 1999 and P1
million on April 25, 2000. Ritz is entitled to receive insurance proceeds of, at most.
P375,000
Ans.
P500,000
P500,000
P600,000
P750,000
A fire insurance policy ordinarily indemnifies for losses arising from?
Friendly, but not hostile, fires
Hostile, but not friendly, fires
Both hostile and friendly fires.
Smoke produced by friendly or hostile fires.
Ans.
Hostile, but not friendly, fires
Which of the following would increase risk?
Increase the level of working capital.
Change the composition of working capital to include more liquid assets.
Increase the amount of short-term borrowing.
Increase the amount of equity financing.
Ans.
Increase the amount of short-term borrowing.
Pod bought a building in 1996 for P220,000. At that time, Pod purchased a P150,000 fire
insurance policy with Owners Insurance Co. and a P50,000 fire insurance policy with
Group Insurance Corp. Each policy contained a standard 80% coinsurance clause. In
2000, when the building had a fair market value of P250,000, it was damaged in a fire.
How much would Pod recover from Owners if the fire caused P180,000 in damage?
P90,000
P120,000
P135,000
P150,000
Ans.
P135,000
An optimal portfolio of investments is?
Efficient because it offers the highest expected return
Any portfolio chosen from the efficient set of portfolios
Any portfolio chosen from the feasible set of portfolios
Tangent to the investor's highest indifference curve
Ans.
Tangent to the investor's highest indifference curve
Which of the following are components of interest-rate risk?
Purchasing-power risk and default risk
Price risk and market risk.
Portfolio risk and reinvestment-rate risk
Price risk and reinvestment-rate risk
Ans.
Price risk and reinvestment-rate risk
Mandarin Co. is considering investing in a zero-coupon bond that sells for $250. At maturity in
16 years, it will be redeemed for $1,000. What approximate annual rate of growth does this
represent?
8%
Ans.
9%
9%
12%
25%
CIA 1191 IV-50
From the viewpoint of the investor, which of the following securities provides the least
risk?
Mortgage bond
Subordinated debenture.
Income bond
Debentures.
Ans.
Mortgage bond
A firm’s financial risk is a function of how it manages and maintains its debt. Which one of the
following sets of ratios characterizes the firm with the greatest amount of financial risk?
debt-to-equity ratio, high interest coverage ratio, stable return on equity.
High
Low debt-to-equity ratio, low interest coverage ratio, volatile return on equity.
High debt-to-equity ratio, low interest coverage ratio, volatile return on equity.
Low debt-to-equity ratio, high interest coverage ratio, stable return on equity.
Ans.
High debt-to-equity ratio, low interest coverage ratio, volatile return on equity.
Business risk is the risk inherent in a firm's operations that excludes financial risk. It
depends on all of the following
factors except:
Amount of financial leverage
Sales price variability
Demand variability
Input price variability
Ans.
Amount of financial leverage
According to the hedging principle (or the principle of self-liquidating debt), in making decisions
concerning the maturity structure of an entity’s financing, which one of the following guidelines
would be most appropriate?
Fund a project with short-term benefits by issuing common stock
Fund a seasonal expansion in inventory by issuing bonds
Fund a project that will benefit eight years with a short term note
Fund a permanent expansion in accounts receivable by issuing long term bonds
Ans.
Fund a permanent expansion in accounts receivable by issuing long term bonds
The purpose of a co-insurance clause is to?
Encourage policyholders to bear a proportionate part of any loss.
Encourage insurers to pay the face amount of the policy in the event of a partial loss on the
part of the insured.
Encourage policyholders to insure commercial property for an amount that is near to its full
replacement cost.
Encourage policyholders to insure commercial property for an amount that is significantly
less than its full replacement cost
Ans.
Encourage policyholders to insure commercial property for an amount that is near to its full
replacement cost.
Larson Corp. issued P20 million of long term debt in the current year. What is a major advantage
to Larson with the debt issuance?
The reduced earnings per share possible through financial leverage.
The relatively low after-tax cost due to the interest deduction
The increased financial risk resulting from the use of the debt
The reduction of Larson's control over the company.
Ans.
The reduction of Larson's control over the company.
CMA 0685 1-1
A company can finance an equipment purchase through a loan. Alternatively, it often can
obtain the same equipment through a lease arrangement. A factor that would not be
considered when comparing the lease financing with the loan financing is ?
Whether the lessor has a higher cost of capital than the lessee.
Whether the property category has a history of rapid obsolescence.
Whether the lessor and lessee have different tax reduction opportunities.
The capacity of the equipment.
Ans.
The capacity of the equipment.
Hart owned a building with a fair market value of P400,000. The building was covered by a
P300,000 fire insurance policy containing an 80% coinsurance clause. What amount would Hart
recover if a fire totally destroyed the building?
P0
P240,000
Ans.
P300,000
P300,000
P400,000
All of the following statements are correct except:
The matching of asset and liability maturities is considered desirable because this strategy
minimizes interest rate risk.
Default risk refers to the inability of the firm to pay off its maturing obligations.
The matching of assets and liability maturities lowers default risk.
An increase in the payables deferral period will lead to a reduction in the need to nonspontaneous funding.
Ans.
The matching of asset and liability maturities is considered desirable because this strategy
minimizes interest rate risk.
The risk of a single asset is?
Nonmarket risk
Ans.
Total risk
Total risk
Portfolio risk
Market risk
CIA 1191 IV-5
A firm must select from among several methods of financing arrangements when meeting
its capital requirements. To acquire additional growth capital while attempting to
maximize earnings per share, a firm should normally?
Attempt to increase both debt and equity in equal proportions, which preserves a
stable capital structure and maintains investor confidence.
Select debt over equity initially, even though increased debt is accompanied by
interest costs and a degree of risk
Select equity over debt initially, which minimizes risk and avoids interest costs.
Discontinue dividends and use current cash flow, which avoids the cost and risk of
increased debt and the dilution of EPS through increased equity.
Ans.
Select debt over equity initially, even though increased debt is accompanied by interest costs and
a degree of risk
Long-term financing is normally concerned with financing for which one of the following
lengths of a time?
One year or less in length
One year to 10 years in length
One year or greater in length
Ten years or greater in length
Ans.
One year or greater in length
Which of the following is a characteristic of fire insurance?
It is more standardized than life insurance
It is written for a relatively short period but usually includes an incontestability clause.
policy must be valued and contain a pro rata clause.
The insurable interest must be an ownership interest in the property itself
Ans.
It is more standardized than life insurance
CMA 0691 1-12
Which one of the following is not a characteristic of a negotiable certificate of deposit?
Negotiable certificates of deposit?
Have a secondary market for investors..
Are regulated by the Federal Reserve System
Are usually sold in denominations of a minimum of P100,000
Have yields considerably greater than bankers' acceptances and commercial paper
Ans.
Have yields considerably greater than bankers' acceptances and commercial paper
Which of the following, if denominated in a foreign currency, is/are subject to currency
exchange risk?
Accounts
Receivable
Accounts
Payable
Yes
Yes
Yes
No
No
Yes
No
No
Yes
Yes
Ans.
A
The typical life insurance policy contains?
No exclusion for death during military service.
A clause allowing coverage for death during noncommercial flight.
A prohibition on reinstatement.
A provision for a grace period for premium payment.
Ans.
A provision for a grace period for premium payment.
The typical life insurance policy contains
No exclusion for death during military service
A clause allowing coverage for death during noncommercial flight
A prohibition on reinstatement
A provision for a grace period for premium payment
Ans.
A provision for a grace period for premium payment
A building that originally cost P60,000 is now worth P200,000. The owner holds a P120,000 fire
insurance policy with an 80% co-insurance clause. If a fire causes P150,000 of damage to the
structure, how much will the owner be able to collect from the insurance company?
P112,500
Ans.
P112,500
P120,000
P150,000
P160,000
An asset with high risk will have a(n) ?
Low expected return
Lower price than an asset with low risk.
Increasing expected return.
High standard deviation of returns
Ans.
High standard deviation of returns
Catherine & Co. has extra cash at the end of the year and is analyzing the best way to invest the
funds. The company should invest in a project only if?
The expected return on the project exceeds the return on investments of comparable risk
The return on investments of comparable risk exceeds the expected return on the project
The expected return on the project is equal to the return on investments of comparable risk
The return on investments of comparable risk equals the expected return on the project
Ans.
The expected return on the project exceeds the return on investments of comparable risk
A firm with cash in excess of its immediate needs is considering a temporary investment
in newly issued 10-year treasury obligations, which pay a fixed rate of interest. If the
investment will be for one year, which of the following risks, if any, would be of
concern?
Default
Risk
Interest
Risk
Yes
Yes
Yes
No
No
Yes
No
No
Ans.
No
Yes
CMA 0697 1-23
All of the following may reduce the coupon rate on a bond issued at par except a:
Sinking fund
Call provision
Change in rating from Aa to Aaa
Conversion option
Ans.
Call provision
The presence of risk for a portfolio of projects means:
More than one outcome is possible for any project
Some projects will lose money
Changes in tax rates are expected to affect all projects
An inadequate number of projects is being undertaken to fully eliminate all risk
Ans.
More than one outcome is possible for any project
Catherine & Co. has extra cash at the end of the year and is analyzing the best way to invest the
funds. The company should invest in a project only if
The expected return on the project exceeds the return on investments of comparable risk.
The return on investments of comparable risk exceeds the expected return on the project.
The expected return on the project is equal to the return on investments of comparable risk.
The return on investments of comparable risk equals the expected return on the project.
Ans.
The expected return on the project exceeds the return on investments of comparable risk.
Efficient portfolios are those which offer:
Highest expected return for a given level of risk
Highest risk for a given level of expected return
The maximum risk and expected return
All of the above
Ans.
Highest expected return for a given level of risk
Which one of the following factors would likely cause a firm to increase its use of debt financing
as measured by the debt-to-total-capitalization ratio?
Increased economic uncertainty.
An increase in the degree of operating leverage.
An increase in the price-earnings ratio
An increase in the corporate income tax rate.
Ans.
An increase in the corporate income tax rate.
A feasible portfolio that offers the highest expected return for a given risk or the least risk for a given
expected return is a(n)
Choice 1
Ans.
Choice 2
Choice 3
Choice 4
Choice 1
Efficient portfolios are those which offer:
Highest expected return for a given level of risk
Highest risk for a given level of expected return
The maximum risk and expected return
All of the above
Ans.
Highest expected return for a given level of risk
Serial bonds are attractive to investors because?
All bonds in the issue mature on the same date.
The yield to maturity is the same for all bonds in the issue
Investors can choose the maturity that suits their financial needs.
The coupon rate on these bonds is adjusted to the maturity date.
Ans.
Investors can choose the maturity that suits their financial needs.
CMA 0692 1-6
The expected rate of return for the stock of Cornhusker Enterprises is 20%, with a
standard deviation of 15%. The expected rate of return for the stock of Mustang
Associates is 10%, with a standard deviation of 9%. The riskier stock is?
Cornhusker because the return is higher
Cornhusker because the standard deviation is higher
Mustang because the standard deviation is higher
Mustang because the coefficient of variation is higher
Ans.
Mustang because the coefficient of variation is higher
In general, it is more expensive for a company to finance with equity capital than with debt
capital because?
Long-term bonds have a maturity date and must therefore be repaid in the future.
Investors are exposed to greater risk with equity capital.
The interest on debt is a legal obligation.
Equity capital is in greater demand than debt capital.
Ans.
Investors are exposed to greater risk with equity capital.
Risk to a company is affected by both project variability and how project returns correlate with
those of the company’s prevailing business. Overall company risk will be lowest when a
project’s returns exhibit?
Low variability and negative correlation.
Low variability and positive correlation
High variability and positive correlation
High variability and no correlation
Ans.
Low variability and negative correlation.
A feasible portfolio that offers the highest expected return for a given risk or the least risk for a
given expected return is a(n)?
Optimal portfolio
Ans.
Efficient portfolio
Desirable portfolio
Efficient portfolio
Effective portfolio
A company uses portfolio theory to develop its investment portfolio. If the company
wishes to obtain optimal risk reduction through the portfolio effect, it should make its
next investment in
An investment that correlates negatively to the current portfolio holdings.
An investment that is uncorrelated to the current portfolio holdings.
An investment that is highly correlated to the current portfolio holdings.
An investment that is perfectly correlated to the current portfolio holdings.
Ans.
An investment that correlates negatively to the current portfolio holdings.
Batanes Company had 150,000 shares outstanding on January 1. On March 1, 75,000 additional
shares were issued through a stock dividend. Then on November 1, the company issued 60,000
shares for cash. The number of shares to be used in the denominator of the EPS calculation for
the year is
222,500 shares.
Ans.
235,000 shares.
225,000 shares.
235,000 shares.
285,000 shares.
CMA 0688 1-2
(Refers to Fact Pattern #2)
Waldwick Corporation is considering issuing a public offering in the amount of
$5,000,000 at the beginning of the year. The company could offer 5,000, 10-year, 10%
bonds at $1,000 face value or 100,000 shares of common stock at $50 per share.
Currently, 500,000 shares of common stock are outstanding and no debt is outstanding.
The company projects $1,000,000 in earnings, before interest and taxes, and has an
effective tax rate of 40%. If Waldwick Corporation selects the common stock alternative,
primary earnings per share for the year would be?
$.60
Ans.
$1.00
$1.20
$1.67
$1.00
Waldwick Corporation is considering issuing a public offering in the amount of
P5,000,000 at the beginning of the year. The company could offer 5,000, 10-year, 10%
bonds at P1,000 face value or 100,000 shares of common stock at P50 per share.
Currently, 500,000 shares of common stock are outstanding and no debt is outstanding.
The company projects P1,000,000 in earnings, before interest and taxes, and has an
effective tax rate of 40%.
[41] Source: CMA 0693 1-18
[42] Source: CMA 0688 1-1
(Refers to Fact Pattern #2)
If Waldwick Corporation selects the bond alternative, the diluted earnings per share
would be?
P.40.
Ans.
P.60
P1.00
P1.20
P.60
Waldwick Corporation is considering issuing a public offering in the amount of
$5,000,000 at the beginning of the year. The company could offer 5,000, 10-year, 10%
bonds at $1,000 face value or 100,000 shares of common stock at $50 per share.
Currently, 500,000 shares of common stock are outstanding and no debt is outstanding.
The company projects $1,000,000 in earnings, before interest and taxes, and has an
effective tax rate of 40%.
[42] Source: CMA 0688 1-1
(Refers to Fact Pattern #2)
If Waldwick Corporation selects the bond alternative, primary earnings per share would
be?
$.40
Ans.
$.60.
$1.00
$1.20
$.60.
The equity section of Smith Corporation’s Statement of Financial Position is
presented below:
Preference shares, P100 par P12,000,000
Ordinary shares, P5 par
10,000,000
Share Premium
18,000,000
Retained earnings
9,000,000
Net worth
P49,000,000
The book value of Smith Corporation’s common stock is
P18.50
Ans.
P5.00
P14.00
P100.00
P18.50
CIA 0596 IV-34
In calculating fully diluted earnings per share when a company has convertible bonds
outstanding, the number of common shares outstanding must be <List A> to adjust for the
conversion feature of the bonds, and the net income must be <List B> by the amount of
interest expense on the bonds, net of tax.
List A
List B
Increased
Increased
Increased
Decreased
Decreased
Increased
Decreased
Decreased
Ans.
Increased
Increased
CIA 0596 IV-33
A company had 150,000 shares outstanding on January 1. On March 1, 75,000 additional
shares were issued through a stock dividend. Then on November 1, the company issued
60,000 shares for cash. The number of shares to be used in the denominator of the EPS
calculation for the year is?
222,500 shares
Ans.
235,000 shares
225,000 shares
235,000 shares
285,000 shares
Waldwick Corporation is considering issuing a public offering in the amount of
P5,000,000 at the beginning of the year. The company could offer 5,000, 10-year, 10%
bonds at P1,000 face value or 100,000 shares of common stock at P50 per share.
Currently, 500,000 shares of common stock are outstanding and no debt is outstanding.
The company projects P1,000,000 in earnings, before interest and taxes, and has an
effective tax rate of 40%.
If Waldwick Corporation selects the bond alternative, the diluted earnings per share
would be
P.40.
Ans.
P.60.
P1.00.
P1.20.
P.60.
Gulf Coast Magnetic Corporation (GCMC) is negotiating an intermediate-term loan to finance a
joint project with another company. GCMC intends to sell its share of the venture to its partner
after 6 years. The lending bank has therefore agreed to structure the loan with a balloon payment
at that time. The amount of the loan is P100,000. GCMC will make level quarterly payments at
an annual rate of 8%. Because the loan is to be only partially amortized, the payments are based
on a full amortization life of 10 years. Which one of the following statements in regard to this
loan is correct? (Round your answer to the nearest dollar.)
The quarterly payment is P3,726.
The quarterly payment is P5,288.
The balloon payment is P12,107
The balloon payment is P49,636
Ans.
The balloon payment is P49,636
Shelf registration of a security is a procedure allowing a firm to
Register an issue price on its securities for a specified period of time.
Control both the issue price and the secondary market price of its securities by
registering these prices for a specified period of time.
Register a security for a specified period of time and then sell the securities on a
piecemeal basis.
Freeze the market price of its new issues of securities for a specified period of time.
Ans.
Register a security for a specified period of time and then sell the securities on a piecemeal basis.
AICPA
Which of the following corporate characteristics would favor debt financing versus equity
financing?
Choice 1
Ans.
Choice 2
Choice 3
Choice 4
Choice 1
AICPA
Which of the following corporate characteristics would favor debt financing versus equity
financing?
A high tax rate
A high debt-to-equity ratio
Low aversion to risk
Below-average stock issuing costs
Ans.
A high tax rate
The par value of a common stock represents?
The estimated market value of the stock when it was issued.
The liability ceiling of a shareholder when a company undergoes bankruptcy proceedings.
The total value of the stock that must be entered in the issuing corporation's records.
theoretical value of P100 per share of stock with any differences entered in the issuing
corporation's records as discount or premium on common stock.
Ans.
The liability ceiling of a shareholder when a company undergoes bankruptcy proceedings.
A
Which of the following corporate characteristics would favor debt financing versus equity
financing?
A high tax rate
A high debt-to-equity ratio
Low aversion to risk
Below-average stock issuing costs
Ans.
A high tax rate
CIA 0593 IV-56
Which of the following scenarios would encourage a company to use short-term loans to retire its
10-year bonds that have 5 years until maturity?
The company expects interest rates to increase over the next 5 years.
Interest rates have increased over the last 5 years
Interest rates have declined over the last 5 years
The company is experiencing cash flow problems
Ans.
Interest rates have declined over the last 5 years
AICPA
Whipco has determined that its pre-tax cost of preferred stock is 12%. If its tax rate 30%,
which one of the following is its after-tax cost of preferred stock?
15.6%
Ans.
12.0%
8.4%
3.6%
12.0%
Bander Co. is determining how to finance some long-term projects. Bander has decided it prefers
the benefits of no fixed charges, no fixed maturity date, and an increase in the credit-worthiness
of the company. Which of the following would best meet Bander's financing requirements?
Bonds.
Common stock
Ans.
Common stock
Long-term debt
Short-term debt
(Refers to Fact Pattern #3)
Monosone, Inc.
Statement of Financial Position
December 31, Year 1
Total assets
P10,000,000
Current liabilities
P 2,000,000
Long-term debt
3,000,000
Common stock (1,000,000
shares authorized,
100,000 shares outstanding at P5
500,000
par value)
Paid-in capital in excess of par
1,600,000
Retained earnings
2,900,000
Total liabilities and shareholders' P10,000,000
equity
Expected dividend payments:
December 31, year 2
December 31, year 3
P2.00
P2.10
December 31, year 4
Expected selling price on
December 31, year 4
Period
1
2
3
4
5
Present
Value
of P1 at
10%
.909
.826
.751
.683
.621
P2.25
P25.00
Future
Value
of P1 at
10%
1.100
1.210
1.331
1.464
1.611
An investor is considering buying Monosone, Inc.'s common stock on January 1, year 2
and anticipates, with reasonable assurance, selling it December 31, year 4 at P25.00 per
share. What is the intrinsic value on January 1, year 2 of each share (rounded to the
nearest dollar) when the required rate of return is 10%?
P31
Ans.
P30
P24
P19
P24
Which one of the following statements is correct when comparing bond financing alternatives?
A bond with a call provision typically has a lower yield to maturity than a similar bond
without a call provision.
A convertible bond must be converted to common stock prior to its maturity.
A call provision is generally considered detrimental to the investor.
A call premium requires the investor to pay an amount greater than par at the time of
purchase.
Ans.
A call provision is generally considered detrimental to the investor.
CMA 1291 1-7
A call provision
Allows bondholders to require the organization to retire the bond before original
maturity.
Lowers the investors' required rate of return
Provides an organization flexibility in financing if interest rates fall
Protects investors against margin calls
Ans.
Provides an organization flexibility in financing if interest rates fall
Karceski Company issues P100,000 of 8% bonds at par. Each bond carries 5 warrants, allowing
the holder to acquire one share of P5 par value common stock for P30 a share. After issuance, the
bonds were estimated at P980 ex-rights, and the warrants were estimated at P6 each. What value
should be assigned to the bonds at issuance?
P87,000
Ans.
P97,030
P97,030
P98,000
P100,000
Which one of the following factors might cause a firm to increase the debt in its financial
structure?
An increase in the corporate income tax rate.
Increased economic uncertainty.
An increase in the Federal funds rate.
An increase in the price-earnings ratio.
Ans.
An increase in the corporate income tax rate.
If a company is experiencing cash flow problems, it will most likely attempt a reorganization
involving?
Replacing some of the debt outstanding with common stock.
Replacing some of the common stock outstanding with debt.
Replacing some of the debt outstanding with preferred stock.
Replacing some of the common stock outstanding with preferred stock.
Ans.
Replacing some of the debt outstanding with common stock.
An issue of securities for which the investment bank handling the transaction gives no guarantee
that the securities will be sold is a(n)?
Competitive bid issue.
Negotiated issue.
Best efforts issue.
Underwritten issue.
Ans.
Best efforts issue.
CMA 1291 1-12
Which one of the following is a disadvantage of the use of convertible bonds as a form of
financing?
Less restrictive covenants in bond indentures would usually be more acceptable to
investors in convertible bonds than to investors in nonconvertible bonds.
Convertible bonds defer equity financing until the stock price is higher.
Convertible bonds carry a lower interest rate at issuance than if the bond were not
convertible.
The investor may choose not to convert the convertible bonds.
Ans.
The investor may choose not to convert the convertible bonds. \
Mississippi Corporation (MC) is negotiating an intermediate-term loan to finance a joint project
with a fellow competitor. MC intends to sell its share of the project to its partner after 6 years.
The lending bank has agreed to structure the loan with a balloon payment at that time. The
amount of the loan is P200,000. MC will make level quarterly payments at an annual rate of 8%.
Because the loan is to be only partially amortized, the payments are based on a full-amortization
life of 10 years. MC's quarterly payment is approximately.
P7,311
Ans.
P7,311
P7,451
P10,574
P10,816
The characteristics of venture capital include all of the following except
Initial private placement for the majority of issues
A minimum holding period of 5 years for new securities
The use of ordinary share for most placements
A lack of liquidity for a period of time
Ans.
A minimum holding period of 5 years for new securities
Which of the following statements concerning common stock is/are generally correct?
I.
II.
III.
Requires dividends be paid.
Grants ownership interest.
Grants voting rights.
I only
Ans.
II and III only
II only
II and III only
I, II, and III
AICPA
Which of
I.
II.
III.
I only
Ans.
the following statements concerning preferred stock is/are generally correct?
Requires dividends be paid.
Grants ownership interest.
Grants voting rights.
II only
I and II only
I, II, and III
II only
CMA 0693 1-16
Junk bonds are?
Securities rated at less than investment grade.
Worthless securities
Securities that are highly risky but offer only low yields.
Considered illegal since the collapse of the Drexel Burnham Lambert firm.
Ans.
Securities rated at less than investment grade.
A firm's optimal capital structure;
Minimizes the firm's tax liability.
Minimizes the firm's risk.
Maximizes the firm's degree of financial leverage.
Maximizes the price of the firm's stock.
Ans.
Maximizes the price of the firm's stock.
Which one of the following characteristics distinguishes income bonds from other bonds?
The bondholder is guaranteed an income over the life of the security.
By promising a return to the bondholder, an income bond is junior to preferred and common
stock.
Income bonds are junior to subordinated debt but senior to preferred and common stock.
Income bonds pay interest only if the issuing company has earned the interest.
Ans.
Income bonds pay interest only if the issuing company has earned the interest.
AICPA
Which one of the following bond issues, with different terms and stated rates of interest, would
have the highest interest rate risk, all other things being equal?
Choice 1
Ans.
Choice 2
Choice 3
Choice 4
Choice 1
AICPA
Larson Corp. issued P20 million of long-term debt in the current year. What is a major
advantage to Larson with the debt issuance?
The reduced earnings per share possible through financial leverage.
The relatively low after-tax cost due to the interest deduction
The increased financial risk resulting from the use of the debt.
The reduction of Larson's control over the company
Ans.
The relatively low after-tax cost due to the interest deduction\
AICPA
In which one of the following area is preferred stock most likely to differ from common
stock?
Ownership status
Maturity date
Tax deductibility of dividends paid
Voting rights
Ans.
Voting rights
AICPA
Which one of the following bond issues, with different terms and stated rates of interest, would
have the highest interest rate risk, all other things being equal?
10-year, 4% bonds.
Ans.
30-year, 4% bonds
10-year, 6% bonds
30-year, 4% bonds
20-year, 4% bonds
CMA 0693 1-17
Which one of the following characteristics distinguishes income bonds from other
bonds?
The bondholder is guaranteed an income over the life of the security.
By promising a return to the bondholder, an income bond is junior to preferred and
common stock.
Income bonds are junior to subordinated debt but senior to preferred and common
stock.
Income bonds pay interest only if the issuing company has earned the interest
Ans.
Income bonds pay interest only if the issuing company has earned the interest
When calculating the cost of capital, the cost assigned to retained earnings should be?
Zero
Lower than the cost of external common equity.
Equal to the cost of external common equity
Higher than the cost of external common equity.
Ans.
Lower than the cost of external common equity.
The market price of a bond issued at a premium is equal to the present value of its principal
amount?
only, at the stated interest rate.
and the present value of all future interest payments, at the stated interest rate.
only, at the market (effective) interest rate.
and the present value of all future interest payments, at the market (effective) interest rate
Ans.
and the present value of all future interest payments, at the market (effective) interest rate
An investor is currently holding income bonds, debentures, subordinated debentures, firstmortgage bonds, and floating rate notes. Which of these securities traditionally is considered to
have the least risk?
Income bonds.
Debentures.
Ans.
First-mortgage bonds.
Subordinated debentures.
First-mortgage bonds.
Junk bonds are:
Securities rated at less than investment grade.
Worthless securities.
Securities that are highly risky but offer only low yields.
Considered illegal since the collapse of the Drexel Burnham Lambert firm.
Ans.
Securities rated at less than investment grade.
(Refers to Fact Pattern #3)
Monosone, Inc.
Statement of Financial Position
December 31, Year 1
Total assets
P10,000,000
Current liabilities
P 2,000,000
Long-term debt
3,000,000
Common stock (1,000,000
shares authorized,
100,000 shares outstanding at P5
500,000
par value)
Paid-in capital in excess of par
1,600,000
Retained earnings
2,900,000
Total liabilities and shareholders' P10,000,000
equity
Expected dividend payments:
December 31, year 2
December 31, year 3
December 31, year 4
Expected selling price on
December 31, year 4
Period
1
2
3
4
5
Present
Value
of P1 at
10%
.909
.826
.751
.683
.621
P2.00
P2.10
P2.25
P25.00
Future
Value
of P1 at
10%
1.100
1.210
1.331
1.464
1.611
The per-share book value of common stock for Monosone, Inc. at December 31, year 1
is?
P50
Ans.
P29
P100
P5
P50
CMA 0693 1-17
Which one of the following characteristics distinguishes income bonds from other
bonds?
The bondholder is guaranteed an income over the life of the security.
By promising a return to the bondholder, an income bond is junior to preferred and
common stock.
Income bonds are junior to subordinated debt but senior to preferred and common
stock.
Income bonds pay interest only if the issuing company has earned the interest
Ans.
Income bonds pay interest only if the issuing company has earned the interest
A call provision is?
Allows bondholders to require the organization to retire the bond before original maturity.
Lowers the investors' required rate of return.
Provides an organization flexibility in financing if interest rates fall.
Protects investors against margin calls.
Ans.
Provides an organization flexibility in financing if interest rates fall.
If a P1,000 bond sells for P1,125, which of the following statements are correct?
I. The market rate of interest is greater than the coupon rate on the bond.
II. The coupon rate on the bond is greater than the market rate of interest.
III. The coupon rate and the market rate are equal.
IV. The bond sells at a premium.
V. The bond sells at a discount.
I and IV
Ans.
I and V
II and IV
II and V
II and IV
All of the following may reduce the coupon rate on a bond issued at par except:
Sinking fund
Call provision
Change in rating from Aa to Aaa
Conversion option
Ans.
Call provision
What impact will the issuing of new preferred stock have on the following for the issuing
entity?
Long-Term
Debt
Debt/Equity
Ratio
Increase
Increase
Increase
Decrease
No Change
Increase
No Change
Decrease
Ans.
No Change
Decrease
Growl Corporation's P1,000 par value convertible debentures are selling at P1,040 when its stock
is selling for P46.00 per share. If the conversion ratio is 20, what will be the conversion price?
P22.61
Ans.
P50.00
P46.00
P50.00
P52.00
Mandarin Co. is considering investing in a zero-coupon bond that sells for P250. At maturity in
16 years, it will be redeemed for P1,000. What approximate annual rate of growth does this
represent?
8%
Ans.
9%
9%
12%
25%
Which of the following statements concerning debenture bonds and secured bonds is/are
correct?
I.
Debenture bonds are likely to have a greater par value than comparable
secured bonds.
II.
Debenture bonds are likely to be longer duration than comparable secured
bonds.
III.
Debenture bonds are more likely to have a higher coupon rate than comparable
secured bonds.
I only.
Ans.
II only.
III only
I, II, and III
III only
Maloney Inc.'s P1,000 par value preferred stock paid its P100 per share annual dividend on April
4 of the current year. The preferred stock's current market price is P960 a share on the date of the
dividend distribution. Maloney's marginal tax rate (combined federal and state) is 40%, and the
firm plans to maintain its current capital structure relationship. The component cost of preferred
stock to Maloney would be closest to?
6%
Ans.
10.4%
6.25%
10%
10.4%
A stock dividend
Increases the debt-to-equity ratio of a firm.
Decreases future earnings per share.
Decreases the size of the firm.
Increases shareholders' wealth.
Ans.
Decreases future earnings per share.
Treating dividends as the residual part of a financing decision assumes that
Earnings should be retained and reinvested as long as profitable projects are
available.
Dividends are important to shareholders, and any earnings left over after paying
dividends should be invested in high-return assets.
Dividend payments should be consistent.
Dividends are relevant to a financing decision.
Ans.
Earnings should be retained and reinvested as long as profitable projects are available.
Residco Inc. expects net income of P800,000 for the next fiscal year. Its targeted and
current capital structure is 40% debt and 60% common equity. The director of capital
budgeting has determined that the optimal capital spending for next year is P1.2 million.
If Residco follows a strict residual dividend policy, what is the expected dividend-payout
ratio for next year?
90.0%
Ans.
66.7%
40.0%
10.0%
10.0%
A firm's balance sheet as of December 31 is shown below. The firm's sales for the year
were P1,000,000,000, and its after-tax margin on sales was 5%. Sales are expected to
increase next year to P1,300,000,000, and it plans to distribute 50% of its net profits to
stockholders. Based on the percentage-of-sales method, the amount of funds that must be
obtained externally by borrowing or by selling new stock is
Assets (P millions)
Cash
Receivables
Inventories
Net fixed assets
P111.50 million.
Ans.
P 50
130
150
220
P165 million.
P65 million.
Liabilities and Equity (P mill
Accounts payable
Accrued taxes & wages
Mortgage bonds
Common stock
Retained earnings
P144 million.
P111.50 million.
If a firm is to be purchased entirely for cash, which of the following items would the
purchaser consider?
I
II
II
I
I and II.
Ans.
The incremental future after-tax cash flow from
operations
Cash paid to the seller's shareholders
The present value of the seller's liabilities
I and III.
I, II, and III.
I.
I, II, and III.
An example of a "poison pill," a form of takeover defense, is
The selling off of profitable units in an attempt to dissuade the hostile corporate
raider.
The issuance of rights that allow shareholders to purchase stock in the proposed
merged company at a substantial discount.
The act of substantially increasing a company's debt.
An agreement to buy back from the hostile raider a large block of stock at a premium.
Ans.
The issuance of rights that allow shareholders to purchase stock in the proposed merged company
at a substantial discount.
When a business becomes insolvent, it
Must be liquidated.
Must be reorganized.
Can be liquidated or reorganized.
Must liquidate enough assets to pay all creditors the full amount they were owed
before it can be reorganized.
Ans.
Can be liquidated or reorganized.
A bankrupt company is being liquidated. The types of claimants on the liquidation value
of the company are listed below:
1.
2.
3.
4.
5.
Secured creditors
Unsecured creditors
The trustee administering the liquidation
Common stockholders
Preferred stockholders
CIA 0594 IV-55
The correct order of distribution of the liquidation proceeds to the various claimants is
1, 2, 5, 4, 3
Ans.
3, 5, 1, 2, 4
1, 3, 5, 2, 4
1, 3, 2, 5, 4
1, 3, 2, 5, 4
If income tax considerations are ignored, how is depreciation expense used in the
following capital budgeting techniques?
Internal rate of return
Payback
Excluded
Excluded
Excluded
Included
Included
Excluded
Included
Ans.
Included
Excluded
Excluded
Which of the following statements is correct regarding financial decision making?
Opportunity cost is recorded as a normal business expense.
The accounting rate of return considers the time value of money.
A strength of the payback method is that it is based on profitability.
Capital budgeting is based on predictions of an uncertain future.
Ans.
Capital budgeting is based on predictions of an uncertain future.
CMA 1295 4-2
Barker Inc. has no capital rationing constraint and is analyzing many independent
investment alternatives. Barker should accept all investment proposals?
If debt financing is available for them.
That have positive cash flows.
That provide returns greater than the before-tax cost of debt.
That have a positive net present value.
Ans.
That have a positive net present value.
CIA 0582 IV-4
Present value, amount of $1, and ordinary annuity information are presented below. All
values are for four periods with an interest rate of 8%.
Amount of $1
Present value of $1
Amount of an ordinary
annuity of $1
Present value of an ordinary
annuity of $1
.36
0.74
4.51
3.31
Jim Green decides to create a fund to earn 8% compounded annually that will enable him to withdraw
$5,000 per year each June 30, beginning in year 5 and continuing through year 9. Jim wishes to make
equal contributions on June 30 of each of the years, year 1 through year 4. Which equation would be used
to compute the balance which must be in the fund on June 30, year 4 for Jim to satisfy his objective?
$X = $5,000 x 3.31
$X = $5,000 x (3.31 + 1.00)
$X = $5,000 x 1.36
$X = $5,000 x 4.51
Ans.
$X = $5,000 x 3.31