Chap 16 - Cash and Marketable Sec.

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MULTIPLE CHOICE Cash flow management 1. Which of the following actions would not be consistent with good management? A. Increased synchronization of cash flows. B. Minimize the use of float. C. Maintaining an average cash balance equal to that required as a compensating balance or that which minimizes total cost. D. Use of checks and drafts in disbursing funds. (rpcpa) 1. B ? The one which is not consistent with good management.  Cash management deals with balancing the cash inflows of the business with that of its cash outflows. In periods where additional cash is needed, the sources of financing must be identified and activated. In periods of excessive cash, the viable investments must be tapped. The following are indicative of good cash management:  Maintaining an optimum cash balance that minimizes the total cost of cash or maintaining a minimum cash balance that equals the required compensating balance.  Speed-up cash collections  Effective credit standards, analysis and approval.  Effective collection policies such as use of mailbox, pick up points, electronic fund transfer, concentration banking, and updated and accurate billing system.  Delay cash payments  Use of drafts.  Use of checks for better internal control and to maximize float.  Use of TGIF (Thank God, Its Friday) policy in the issuance of checks.  Bill first, before payment policy. Choice-letter “a”, “c” and “d” are all good cash management policies. Choiceletter “b”, minimizing the use of payment float, is not a good cash payment policy. 2. Which of the following investments is not likely to be a proper investment for temporary idle cash? A. Initial public offering of an established profitable conglomerate. B. Commercial paper. C. Treasury bills. D. Treasury bonds due within one year. (rpcpa) 2. D ? The one that is not likely to be a proper investment in temporary idle cash.  Idle (or excess) cash ought to be used (or invested) somewhere to give a fair return and contribute in increasing the common equity of the firm. If the excess cash is temporary, place it in temporary investments. If the excess cash is permanent, place it in permanent investments.

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Temporary investments are those expected to be converted into cash in a short notice. Examples of temporary investments are short-term time deposits, promissory notes, Philippine Treasury Bills, negotiable instruments, and other short-term commercial papers, and those in the securities but are readily marketable (such as temporary investments in shares of stocks and bonds). Initial public offering (IPO) of an established conglomerate, commercial papers and treasury bills are examples of temporary investments. Treasury bonds within one year, are not temporary in nature (e.g., one year) plus the fact that the investments are in bonds (where the bond market is not active in the Philippine financial markets) and that bonds are in treasury. Hence, choice-letter “d” is correct. 3. A precautionary motive for holding excess cash is A. To enable a company to meet the cash demands from the normal flow of business activity. B. To enable a company to avail itself of a special inventory purchase before prices rise to higher levels. C. To enable a company to have cash to meet emergencies that may arise periodically. D. To avoid having to use the various types of lending arrangements available to cover projected cash deficits. (rpcpa) 3. C ? A precautionary motive for holding cash.  Under normal conditions, there are three (3) reasons why businesses hold cash: transactional motive, precautionary motive, and speculative motive. Transactional motive relates to the daily and normal use of cash to finance the business daily operating requirements. Precautionary motive relates to the occurrence of exigencies or emergencies where extra cash is needed. Speculative motive refers to ability of the company to stay ahead in competition by intellectually predicting business trends (e.g., buying more inventory before prices increases in times of recession, also called as black-marketing). Choice-letter “c” is the correct answer; it refers to precautionary motive of holding cash. Choice-letter “a” is a transactional motive. Choice-letter “b” is a speculative motive. Choice-letter “d” relates to prudent cash planning and management. 4. The following practices will impact the cash flow of the company: 1. Sales personnel are unequivocally responsible for collecting their credit sales. 2. Sales commissions are based on collected invoices. 3. Statement of accounts receivable are reconciled with customers and regularly sent for confirmation. 4. Automatic transfer of funds is arranged with banks regarding deposits of branches. Of the above, which will result to better cash flow? A. All statements. C. Statements 3 and 4 only. B. Statements 1, 3, and 4 only. D. Statement 4 only. 4. C ? The practice(s) that results to better cash flows.

(rpcpa)

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Choice-letter “c” is correct. The practices mentioned in statements 3 and 4 refer to collection policies. Reconciliation and confirmation of accounts with customers and automatic transfer of funds regarding bank deposits of branches are meant to result to better cash flows. Statements 1 and 2 will result to weak cash flow controls since sales are operating functions while collection of credit sales is a custodianship (e.g., treasurer’s function). Combining these two functional responsibilities into the hand of a person would diminish the effectiveness of internal control, and therefore, will not result to better cash flows.

5. A compensating balance A. Compensates a financial institution for services rendered by providing it with deposits of funds. B. Is used to compensate for possible losses on a marketable securities portfolio. C. Is a level of inventory held to compensate for variations in usage rate and leadtime. D. Is the amount of prepaid interest on a loan. (cma) 5. A ? A statement about compensating balance.  A compensating balance is normally required by financing institutions to be maintained or deposited by the borrower as his equity contribution on the amount borrowed. Choice-letter “a” is correct. Effectively, a compensating balance increases the effective borrowing rate by reducing the net proceeds of the amount borrowed. Choice-letter “b” is incorrect because a compensating balance is used for cash borrowings and not for marketable securities portfolio transactions. Choice-letter “c” is incorrect because it refers to safety stock. Choice-letter “d” is incorrect because it refers to discounted interest on the loan. 6. An automated clearing house (ACH) electronic transfer is a(an) A. Electronic payment to a company’s account at a concentration bank. B. Check that must be immediately cleared by the Bangko Sentral ng Pilipinas. C. Computer-generated deposit ticket verifying deposit of funds. D. Check like instrument drawn against the payor and not against the bank. 6. A ? A description about automated clearing house (ACH) electronic transfer.  Electronic transfer (or electronic fund transfer or EFT) is a movement of cash balance from an account to another using electronics technology. This is normally harnessed by collecting companies to expedite collections from customers, near or far, by means of electronic fund transfer services offered by banks and other financing institutions. Choice-letter “a” is correct. Choice-letter “b” is incorrect because it refers to outstanding checks, and a check is not involved in EFT. Choice-letter “c” is incorrect because it relates to deposits from various sources and not transfer of funds from specific customers. Choice-letter “d” is incorrect because an EFT is not a check-like instrument.

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7. A working capital technique that increases the payable float and therefore delays the outflow of cash is A. Concentration banking. B. A draft.

C. Electronic data interchange (EDI). D. A lockbox system.

(cma)

7. B ? A working capital technique that increases the payable float and delays the outflow of cash.  Float refers to the period of time a check or a draft is cleared through the banking system. A draft is a 3-party instrument in which a drawer orders the drawee to pay the money to the payee, and is a means of slowing cash outflows. It normally takes an extra day to clear a draft than a check. Hence, choice-letter “b” is correct. Choice-letters “a” and “d” are incorrect because concentration banking and lockbox system are means of accelerating cash inflows. Choice-letter “c” is incorrect because an EDI is an electronic technique used by suppliers and customers to facilitate faster delivery of quality materials. 8. Which one of the following is not a characteristic of a negotiable certificate of deposit? Negotiable certificates of deposit A. Have a secondary market for investors. B. Are regulated by the Bangko Sentral ng Pilipinas. C. Are usually sold in denominations of a minimum of P100,000. D. Have yields considerably greater than bankers’ acceptances and commercial paper. (cma) 8. D  The description that is not a characteristic of negotiable certificate of deposit.  A certificate of deposit (CD) is a form of savings deposit that cannot be withdrawn before its maturity without incurring a higher penalty. Sometimes, it is called as the certificate of time deposit. Other CDs may be traded, hence they are called as negotiable certificate of deposit. This form of temporary investment is less risky than that of commercial paper and bankers’ acceptances, and therefore yields a lower, not higher, rate. Choice-letter “d” is correct. Choice-letters “a”, “b”, and c” are incorrect because negotiable certificate of deposits are negotiable and therefore have secondary market, regulated by BSP since they are channeled through the banking sector, and are usually sold with minimum denominations 9. The most direct way to prepare a cash budget for a manufacturing firm is to include A. Projected sales, credit terms, and net invoice. B. Projected net income, depreciation and goodwill amortization. C. Projected purchases, percentages of purchases paid, and net income. D. Projected sales and purchases, percentages of collections, and terms of payments. (cma) 9. D ? The items included in the direct way of preparing cash budget.

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Cash budget is the financial plan regarding cash inflows and outflows of a firm in a given period. A cash budget prepared on a direct way itemizes cash receipts and disbursements. The more visible components of a cash budget prepared on a direct way are collections from customers and payments to merchandise suppliers, salaries, and other important operating expenses. As such, choice-letter “d” is correct. Budgeted collections from customers are coming from projected sales while budgeted payments to suppliers originate from purchases. Choice-letter “a” is incorrect because it does not include cash payments. Choiceletter “b” is incorrect because depreciation and goodwill amortizations are added back to net income in computing the net cash flows from operations using the indirect method of cash flows presentation. Choice-letter “c” is incorrect because it does not include sources of cash receipts. Given the following events, which affect cash flows from operations? 1. Cash sale 2. Cash dividends paid 3. Purchase of a long-term asset 4. Purchase of inventory 5. Paid employees A. 1 and 5. B. 1, 3, 4, and 5.

C. 1, 2 and 5. D. 1, 4 and 5.

(rpcpa)

10. A ? The transactions that affect cash flows from operations.  Choice-letter “a “ is correct; cash sale is a cash inflow from operations and payment to employees is a cash outflow to operations. Item no. 2, payment of cash dividend, is a financing activity. Item no. 3 does not specify whether the purchase is cash or non-cash and if ever purchased on cash is to be classified as an investing activity. Item no. 4 does not mention whether the purchase of inventory is on cash, hence, assumed to have been made on account. 11. MM Corporation had income before taxes of P60,000 for the year 2006. Included in this amount was depreciation of P5,000, a charge of P6,000 for the amortization of bond discounts, and P4,000 for interest expense. The estimated cash flow for the period is A. P60,000 C. P49,000 B. P66,000 D. P71,000 (cma) 11. D ? The estimated cash flow for the period.  The cash flow from operations may be computed using the indirect method of cash flow presentation, as follows: Income before income taxes P60,000 ± Non-cash items: Depreciation expense 5,000 Bond discounts amortization 6,000 Net cash inflow from operations P71,000

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The income before income taxes automatically becomes the net income because there is no applicable tax rate given. 12. Bing and Bong’s Store is on the cash basis of preparing it funds statement. These data are available: Decrease in working capital P50,000 Depreciation 13,000 Increase in cash 25,000 Repairs and maintenance 19,500 Total uses of cash 454,000 Calculate the total sources of cash of Bing and Bong’s Store . A. P472,500 C. P479,000 B. P492,000 D. P467,000

(rpcpa)

12. C ? The total sources of cash.  The total use of cash is given together with the increase in cash balance. Based on the data given in the problem, the total sources of ash is P479,000, as determined below: Total uses of cash P454,000 Add: Increase in cash 25,000 Total sources of cash P479,000 Better still, if the cash balance beginning is given. The total sources of cash shall then be cash balance beginning plus total uses of cash. 13. Shown below is a forecast of sales for Carlos Inc. for the first four months of 2006 (all amounts are in thousand of pesos). 2006 January February March April Cash sales P 15 P 24 P 18 P 14 Sales on credit 100 120 90 70 On average, 50% of credit sales are paid for in the month of sale, 30% in the month following the sale, and the remainder is paid 2 months after the month of sale. Assuming there are no bad debts, the expected cash inflow for Carlos in March is A. P138,000 C. P119.000 B. P122,000 D. P108,000 (cma) 13. C  The expected cash inflows in March 2006.  The credit sales collection pattern is 50-30-20, which means that March credit sales collection will come from January sales (20%), February sales (30%), and March sales (50%), as follows: Collections from credit sales: January sales (P100,000 x 20%) P 20,000 February sales (P120,000 x 30%) 36,000 March sales (P90,000 x 50%) 45,000

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18,000 P119,000

14. Assume that each day a company writes and received checks totaling P10,000. If it takes 5 days for the checks to clear and be deducted from the company’s account, and only 4 days for the deposits to clear, what is the float? A. P10,000 C. P(10,000) B. P 0 D. P50,000 (cma) 14. A ? The amount of the float.  The float referred here is the net float. A float is a time spent between the day the check is written until the day the check is withdrawable or the deposit is cleared. The net float refers to the difference of the check float and the deposit float, as follows: Check float (P10,000 x 5 days) P50,000 Deposit float (P10,000 x 4 days) ( 40,000) Net float (P10,000 x 1 day) P10,000 15. Butit is a newly established janitorial firm, and the owner is deciding what type of checking account to open. Butit is planning to keep a P500 minimum balance in the account for emergencies and plans to write roughly 80 checks per month. The bank charges P10 per month per P0.10 per check charge for a standard business checking account with no minimum balance. Butit also has the option of a premium business balance that requires a P2,500 minimum balance but has no monthly fees or per check charges. If Butit’s cost of funds is 10%, which account should Butit choose? A. Standard account, because the savings is P34 per year. B. Premium account, because the savings is P34 per year. C. Standard account because the savings is P16 per year. D. Premium account because the savings is P16 per year. (cma) 15. D ? The checking account that should be chosen.  The checking account to be maintained should give the lower cost of using the checking account facility, as follows: Cost of using a standard checking account Bank charges [P10 + (80 x P0.10) x 12 mos.] P216.00 Cost of funds (P500 x 10%) 50.00 P266.00 Cost of using premium checking account (P2,500 x 10%) 250.00 Advantage of using the premium checking account P 16.00 16. Globe Products has received proposals from several banks to establish a lock box system to speed up receipts. Globe receives an average of 700 checks per day averaging P1,800 each, and its cost of short-term funds is 7% per year. Assuming that all proposals will produce equivalent processing results and using a 360-day year, which one of the following proposals is optimal for Globe? A. A P0.50 per check. B. A flat fee of P125,000 per year.

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C. A fee of 0.03% of the amount collected. D. A compensating balance of P1,750,000.

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(cma)

16. D ? The optimal proposal received from several banks.  The business receives 700 checks per day, an average of P1,800 a day, and a cost of funds of 7% per year. The costs of the several proposals are: Cost of proposals a. P0.50 per check (700 checks x P0.50 x 360 days) P126,000 b. Flat fee 125,000 c. 0.03% of amount collected (P1,800 x 700 checks x 360 days x 0,03%) 136,080 d. Compensating balance (P1,750,000 x 7%) 122,500 (lowest) Proposal “d”, maintaining a compensating balance of 1,750,000 would only cost the business P122,500, and has the lowest cost among the proposals submitted, and therefore is the most desirable and optimal proposal. 17. Franklin, Inc., is a medium-size manufacturer of toys that makes 25% of its sales to Mel Company, a major national discount retailing firm. Mel will be requiring Franklin and other suppliers to use Electronic Data Interchange (EDI) for inventory replenishment and trade payments transactions as opposed to the paper-based systems previously used. Franklin would consider all of the following to be advantages using EDI in its dealings with Mel except A. Access to Mel’s inventory balances of Franklin’s products. B. Better status of deliveries and payments. C. Compatibility with Franklin’s other procedures and systems. D. Reduction in the payment float. (cma) 17. D ? A disadvantage using EDI in dealing with a supplier.  Electronic data interchange (EDI) is an electronic system where a company that has an interest over the operational schedules of another (e.g., its customers) taps the advantages of advance communication and computer technologies in order to deliver services on time and upholding the best interest of the receiving party. For example, this method allows a supplier to dip or access over the database of its customer to predict production needs and serve schedules on time to eliminate delays (or production float) in the production process. This process ensures better status of deliveries and results to timely payments on the part of the buying party. Choiceletters “a”, “b”, and “c” are advantages of the EDI and are not the correct answers. Choice-letter “d” is incorrect and is the correct answer because reduction in the payment float would not lengthen the payment period and is a disadvantage using the EDI. 18. If the average age of inventory is 60 days, the average age of the accounts payable is 30 days, and the average age of accounts receivables is 45 days, the number of days in the cash flow cycle is A. 135 days. C. 75 days.

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D. 105 days.

18. C ? The number of days in the cash flow cycle.  Net cash flow cycle is operating cycle less payment period. Operating cycle is the sum of collection period plus days to sell inventory, as follows: Operating cycle (45 days + 60 days) 105 days - Payment period 30 days Net cash flow cycle 75 days 19. RMN is a retail mail order firm that currently uses a central collection system that requires all checks to be sent to its flotation headquarters. An average of 6 days is required for mailed checks to be received, 3 days for RMN to process them, and 2 days for the checks to clear through its bank. A proposed lockbox system would reduce the mailing and processing time to 2 days and the check clearing time for 1 day. RMN has an average daily collection of P150,000. If RMN adopts the lockbox system, its average cash balance will increase by A. P1,200,000 C. P600,000 B. P 750,000 D. P450,000 19. A ? The increase in the average cash balance if the company adopts the lockbox system.  The average cash balance is an increase of 5 days, presented as follows: Old check processing time (6 + 3 + 2) 11 days - Lockbox system (2 + 1) 3 days Reduction in the collection time 8 days Increase in average cash balance (P150,000 x 8 days) P1,200,000 20. A firm has a daily cash receipts of P100,000 and collection time of 2 days. A bank has offered to reduce the collection time on the firm’s deposits by 2 days for a monthly fee of P500. If money market rates are expected to average 6% during the year, the net annual benefit (loss) from having this service is A. P 3,000 C. P 0 B. P12,000 D. P6,000 (cma) 20. D ? The net annual benefit (loss).  The benefit arises from reduced collection time by days in which cash may be invested at an average return of 6% per year. The cost of the accelerated collection period is the bank monthly charge of P500. The net benefit is determined as follows: Benefit from accelerated collection (P100,000 x 2 days x 6%) P12,000 - Bank charges (P500 x 12 mos.) 6,000 Net benefit from reduced collection time P 6,000 21. Troy Toy is a retailer operating in several cities. The individual store managers deposit daily collections at a local bank in a non-interest bearing checking account. Twice per week, the local bank issued a depository transfer check (DTC) to the

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central bank at headquarters. The controller of the company is considering using a wire transfer instead. The additional cost of each transfer would be P25; collections would be accelerated by 2 days, and the annual interest rate paid by the central bank is 7.2% (0.02% per day). At what amount of pesos transferred would it be economically feasible to use a wire transfer instead of the DTC? Assume a 350-day year. A. It would never be economically feasible. B. P125,000 or above. C. Any amount greater than P173. D. Any amount greater than P62,500. (cma) 21. D ? The amount to be transferred to be economically feasible to use a wire transfer instead of the DTC.  If the wire transfer is used, a cost of P25 is incurred. The benefit from the use of wire transfer is the interest of .02% a day or .04% for 2 days. The minimum amount that should be transferred to at least cover the P25 cost is P62,500 (i.e., P25/0.04%). Choice-letter “a” is incorrect because it is feasible to use wire transfer if the amount of cash to be transferred is P62,500 or more. Choice-letters “b” and “c” are incorrect because the minimum amount of transfer should be P62,500 or more. 22. A company uses the following formula in determining the optimal level of cash if: b = fixed cost per transaction C = 2bt / I I = interest rate on marketable securities t = total demand for cash over a period of time This formula is a modification of the economic order quantity (EOQ) formula used for inventory management. Assume that the fixed cost of selling marketable securities is P10 per transaction and the interest rate on marketable securities is 6% per year. The company estimates that it will make cash payments of P12,000 over the onemonth period. What is the average cash balance (rounded to the nearest peso)? A. P1,000 C. P3,464 B. P2,000 D. P6,928 (cma) 22. C ? The average cash balance.  The total annual cash payments are P144,000 (i.e., P12,000 x 12 months). The optimal cash balance is P6,928, computed as follows: C = C =

2 x P144,000 x P10 6% P6,928

The average cash balance is P3,464 (i.e., P6928 / 2 ). 23. A firm has daily cash receipts of P300,000. A bank has offered to provide a lockbox service that will reduce the collection time by 3 days. The bank requires a monthly fee of P2,000 for providing this service. If monthly market rates are expected to

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average 6% during the year, the additional annual income (loss) of using the lockbox system is A. P(24,000) C. P30,000 B. P12,000 D. P54,000 (ing) 23. C  The additional annual income (loss) of using the lockbox system.  The benefit-cost analysis should be used. The benefit from the use of the lockbox system reduces the collection time by 3 days, which means that the collected amount may by invested to earn a return of 6%. The related cost in using the lockbox system is the bank’s monthly charges of P2,000. The net benefit (loss) from the use of the lockbox system is P30,000, determined as follows: Benefit from accelerated collection (P300,000 x 3 days x 6%) P54,000 - Bank charges (P2,000 x 12 mos.) 24,000 Net benefit from using the lockbox system P30,000 24. The treasury analyst for KG Manufacturing has estimated the cash flows for the first half of next year (ignoring any short-term borrowings) as follows: Cash (millions) Inflows Outflows January P 2 P 1 February 2 4 March 2 5 April 2 3 May 4 2 June 5 3 KG has a line of credit up to P4 million on which it pays interest monthly at a rate of 1% of the amount utilized. KG is expected to have a cash balance of P2 million on January 1 and no amount utilized on its line of credit. Assuming all cash flows occur at the end of the month, approximately how much will KG pay in interest during the first half of the year? A. Zero C. P 50,000 B. P61,000 D. P132,000 (cma) 24. B  The amount of interest paid during the first half of the year.  The amount of interest paid is 1% per month of the outstanding balance of amount borrowed, computed as follows: Monthly net Cash balance Financing Flows cash inflows before Borrowings Date (outflows) borrowings (Payments) Interest paid Jan 1 P2,000,000 P 0 P 0 P 0 Jan 1,000,000 3,000,000 0 0 Feb 28 (2,000,000) 1,000,000 0 0 Mar 31 (3,000,000) (2,000,000) 2,000,000 0 Apr 30 (1,000,000) (1,000,000) 1,000,000 20,000 (P2,000,000 x 1%) May 31 2,000,000 0 (1,949,800) 30,200 (P3,020,000 x 1%)

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10,502 (P1,050,200 x 1%) P60,702

The total interest to be paid from January 1 to June 30 is P60,702, choice-letter “b” is the nearest answer. The interest paid on May 31 is based on P3,020,000 (i.e., P2,000,000 + P1,000,000 + P20,000). The interest incurred on April 30 and unpaid in May also earns interest. The total borrowings paid on May 31 is P1,949,800 (i.e., P2,000,000 – P50,200). The total interest of P50,200 (i.e., P20,000 + P30,200) is paid on May 31. In June, the interest is based on the outstanding borrowings of P1,050,200 (i.e., P3,000,000 – P1,949,800). And the June 30 cash balance is P939,298 (i.e., P2,000,000 – P1,050,200 – P10,502). Effective interest rate 25. On January 07, 2006, Dean Company discounted its own P100,000, 180-day note at United National Bank at a discount rate of 20%. Dean repaid the note on the July 6, 2005, due date. Based on a 360-day year, the effective rate of interest on the borrowing was A. 18.2% C. 22.2% B. 20.0% D. 25.0% (aicpa) 25. D ? The effective interest-borrowing rate.  Effective interest borrowing rate is the true rate of interest rate paid or incurred by the business. The basis of the interest rate is the proceeds from borrowing. In this case, the effective borrowing rate is 25% [i.e., 20% / (100% - 20%)]. The interest is deducted in advance because it is discounted. 26. A company obtained a short-term bank loan of P250,000 at an annual interest of 6%. As a condition of the loan, the company is required to maintain a compensating balance of P50,000 in its checking account. The company’s checking account earns interest at an annual rate of 2%. Ordinarily, the company maintains a balance of P25,000 in its checking account for transaction purposes. What is the effective interest rate of the loan? A. 6.44% C. 5.80% B. 7.00% D. 6.66% (cma) 26. A ? The effective interest rate of the loan.  Effective interest borrowing rate (EIBR) is the true interest rate paid by the business on the amount borrowed. EIBR is net interest expense divided by net proceeds of borrowings. The basis of the effective interest rate is the proceeds from borrowing, not the principal amount borrowed. Interest payments should be adjusted with related interest revenue that may be derived from the conditions set in the borrowing agreement (such as interest revenue from compensating balance). In this problem, the interest paid is P15,000 (i.e., P250,000 x 6%). The compensating balance of the company should be increased by P25,000 (i.e., P50,000 – P25,000) and earns an interest revenue of P500 (i.e., P25,000 x 2%). The

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net proceeds from borrowings are P225,000 (i.e., P250,000 – P25,000). effective interest-borrowing rate is computed as follows: EIBR = Net interest paid / Net proceeds = (P15,000 – P500) / P225,000 = P14,500 / P225,000 = 6.44%

242 The

27. Hager Company’s bank requires a compensating balance of 20% on a P100,000 loan. If the stated interest on the loan is 7%, what is the effective cost of the loan? A. 5.83% C. 6.40% B. 7.00% D. 8.75% (cma) 27. D ? The effective cost of the loan.  The effective cost of the loan is determined by dividing the net interest expense over the net proceeds of the loan. The interest expense associated with the loan is P7,000, and the net proceeds of the loan is P800,000 (i.e., P1 million x 80%). The effective cost of the loan is 8.7%, as follows: Effective loan rate = P7,000 ÷ P800,000 = 8.75% 28. Meals Etc. has been very successful. It is the newest fast food outlet at the Greenbelt of Makati featuring ordinary Filipino food packed with banana leaves. After six months of operations, it needs to expand. The owner, Mr. K. Eng estimates that P2.4 million will be required to put up another outlet in the Ortigas area. Financing was offered by a friendly banker at 10 percent discounted interest. Alternatively, Mr. Eng is thinking of just delaying payment to its suppliers. All his sales are on cash basis. The company purchases under terms of 2/10, net 40 but Mr. Eng believes that he could delay payments by another 30 days without any problem. This means payment could be made in 70 delays. Assuming 360 days a year, Meals Etc. should opt for A. Bank loan since its cost of 11.11% is cheaper than the cost of delaying payments of 12.24%. B. Delaying payments since it has no cost compared to the 10% discounted bank interest. C. Bank loan since it costs of 10% is cheaper than the cost of delaying payments of 12%. D. Delaying payments since it costs only 2% compared to 10% discounted bank interest. (rpcpa) 28. A ? The better short-term financing alternative.  The two short-term financing alternatives are: (1) borrow from the bank, or (2) delay payments to suppliers. The effective cost of financing for each alternative is as follows: a. Borrow from a bank Effective interest rate = [10% / (100% - 10%)] = 11.11% b. Delay payments to suppliers Effective discount rate = (360/60) x (2%/98%) = 12.24%

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It is better for the firm to borrow from a local bank and pay a lower cost of shortterm financing at 11.11%. 29. Butuan Company recently received a commercial bank loan of 16% discounted rate with a 20% compensating balance. The term of the loan is one year. The effective cost of borrowing is: A. 19.05% C. 22.85% B. 20.00% D. 25.00% (rpcpa) 29. D ? The effective cost of borrowing.  Effective interest borrowing rate is the true interest rate paid by the business. The basis of the interest rate is the proceeds from borrowing and not the principal amount borrowed. Interest payments should be adjusted with related interest revenue that may be derived from the conditions set in the borrowing agreement (such as interest revenue from compensating balance). Based on the given data, the effective interest rate is: Effective interest rate = Interest rate / (Principal – Interest rate – Compensating balance)

= 16% / (100% - 16% - 20%) = 16% / 64% = 25% 30. Cool and Sweet obtained a short-term bank loan for P1 million at an annual interest of 12%. As a condition of the loan, the company is required to maintain a compensating balance of P200,000 in its savings account which earns interest at an annual rate of 6%. The company would otherwise maintain only P100,000 on the savings account for transactional purposes. The effective cost of the loan is A. 13.20% C. 12% B. 12.67% D. 13.5% (rpcpa) 30. B ? The effective cost of the loan.  The effective loan rate is equal to net interest expense paid divided by net amount received. The computation is shown below: Regular interest expense (P1 million x 12%) P120,000 Interest income on compensating balance (P100,000 x 6%) ( 6,000) Net interest incurred 114,000 / by Net amount received : Principal P1,000,000 Increase in compensating balance (100,000) 900,000 Effective interest rate 12.67% Net interest paid equals the regular interest payments less the interest revenue from the compensating balance. The increase in compensating balance decreases the net proceeds. The loan is not discounted, as such the interest is not deducted in advance. 31. The Ralph, Inc. signed a loan agreement subject to the following terms: 1. Stated interest rate of 18% on a one-year discounted loan; and 2. 15% compensating non-interest bearing checking account balance to be maintained by Ralph Inc., with Manila Commercial Bank

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The net proceeds of the loan was P1 million. The principal amount of the loan was A. P1,176,471 B. P1,000,000

C. P1,492,537 D. P1,219,512

(rpcpa)

31. C ? The principal amount of the loan.  The net proceeds of the loan is P1 million. The discounted interest is 18% and the compensating balance is 15%. The net proceeds rate is 67% (i.e., 100% - 15% 18%). The amount of the principal is P1,492,537.00 computed by dividing P1 million over 67%. Discounted interest means that the interest is deducted in advance. Marketable securities management 32. When managing cash and short-term investments, a corporate treasurer is primarily concerned with A. Maximizing the rate of return. B. Maximizing taxes. C. Investing in Treasury bonds since they have no default mix. D. Liquidity and safety. 32. D ? An area of concern of a corporate treasurer with respect to managing cash and shortterm investments.  A corporate treasurer is concerned about liquidity and safety in managing cash and short-term investments. Managing short-term liquidity needs precision in timing cash flows in order to avoid unnecessary delays or failures in paying currently maturing obligations as they fall due. Sufficient liquidity must always be established to minimize the risk of technical bankruptcy. This is done by ensuring enough cash to meet payments of crucial operating expenses. Short-term investments are made under the criteria that their convertibility to cash is immediate and assured, with secondary interests on their possible returns. Choice-letter “a” is incorrect because ordinary businesses are established to maximize earnings from their main source of revenue and not from secondary sources of revenue. Choice-letter “b” is incorrect because maximizing taxes is an antithesis of business goals. Choice-letter “c” is incorrect because treasury bonds are not short-term investments. 33. All of the following are alternative marketable securities suitable for investment except A. RP Treasury Bills. C. Commercial paper. B. Eurodollars. D. Convertible bonds. (cma) 33. D ? An investment, which is not an alternative marketable securities.  Marketable securities are equity papers representing ownership and credit accommodations expected to earn a reasonable return. Examples of marketable

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securities are listed company’s shares of stocks and bond certificates. Aside from marketable securities, there are alternative temporary investments where temporary excess cash may invested such as treasury bills, commercial papers, and, recently, eurodollars. Hence, choice-letters “a”, “b”, and “c” are incorrect because they are not exception to the alternative marketable securities. Choice-letter “d” is the right answer because convertible bonds are normally long-term in nature and are therefore not temporary. 34. The term short selling is the A. Selling of a security that was purchased by borrowing money from a broker. B. Selling of a security that is not owned by the seller. C. Selling of all the shares you own in a company in anticipation that the price will decline dramatically. D.

Betting that stock will increase by a certain amount within a given period of time. (cma)

34. B ? A statement of description about short selling.  Choice-letter “b” is correct. Short selling is done be selling securities not owned by the seller but is borrowed or on loaned from a broker. Later, the securities are returned by buying the same securities in the open market at a lower price. This is one area of speculative stock selling. Choice-letter “a” is incorrect because it refers to margin trading where the securities are purchased by borrowing from a broker and selling the same securities at expectedly higher price, pay the broker, and profit along the way. Choice-letter “c” is incorrect because in short selling the securities are not owned by the seller. Choice-letter “d” is incorrect because in short selling the seller is betting that the stock price will decrease at a later time.

 done 

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