ACC 7 – MANAGEMENT CONSULTANCY

TEST BANK

RESPONSIBILITY ACCOUNTING

PROBLEM 1

Midland Division, which is part of Courtyard Enterprises, recently reported a sales margin of 30%, ROI of 21%, and
residual income of P220,000. Courtyard uses an imputed interest rate of 10%.

Required:
A. Compute Midland's capital turnover and invested capital.
B. Ignoring your work in requirement "B," assume that invested capital amounted to P2,500,000. On the
basis of this information, calculate Midland's income and sales revenue.

Answer:

A. Capital turnover:
Capital turnover x sales margin = ROI
Capital turnover x 30% = 21%
Capital turnover = 0.7

Invested capital:
ROI = Income ÷ invested capital
21% = Income ÷ invested capital
Income = Invested capital x 21%

Residual income = Income - (invested capital x imputed interest rate)

P220,000 = Income - (invested capital x 10%)
P220,000 = (Invested capital x 21%) - (invested capital x 10%)
P220,000 = Invested capital x 11%
Invested capital = P2,000,000

B. Income:
ROI = Income ÷ invested capital
21% = Income ÷ P2,500,000
Income = P525,000

Sales revenue:
Sales margin = Income ÷ sales revenue
30% = P525,000 ÷ sales revenue
Sales revenue = P1,750,000

PROBLEM 2

The following data pertain to Norris Company for 20x1:

Sales revenue P1,000,000

Cost of goods sold 550,000
Operating expenses 400,000
Average invested capital 500,000
Required:
A. Calculate the company's sales margin, capital turnover, and return on investment for 20x1.
B. If the sales and average invested capital remain the same, to what level would total costs and expenses
have to be reduced in 20x2 to achieve a 15% return on investment?
C. Assume that costs and expenses are reduced, as calculated in requirement "B." Calculate the firm's new
sales margin.
D. Suggest two possible actions that will improve the company's capital turnover.

Answer:

A. Sales revenue P1,000,000

Less: Cost of goods sold P550,000
Operating expenses 400,000 950,000
Operating income P 50,000

Sales margin: P50,000 ÷ P1,000,000 = 5%

Capital turnover: P1,000,000 ÷ P500,000 = 2
Return on investment: P50,000 ÷ P500,000 = 10%

B. New income level: P500,000 x 15% = P75,000

Sales revenue P1,000,000

Less: Income 75,000
Costs and expenses P 925,000

Therefore, total costs and expenses must be reduced from P950,000 (P550,000 +
P400,000) to P925,000 in order to achieve a 15% ROI.

C. Sales margin: P75,000 ÷ P1,000,000 = 7.5%

D. Capital turnover can be improved by increasing sales revenue and reducing invested
capital.

PROBLEM 3

The following data pertain to the Oxnard Division of Kemp Company:

Divisional contribution margin P 700,000

Profit margin controllable by the divisional manager 320,000
Profit margin traceable to the division 294,400
Average asset investment 1,280,000

The company uses responsibility accounting concepts when evaluating performance, and Oxnard's division manager
is contemplating the following three investments. He can invest up to P400,000.

No. 1 No. 2 No. 3

Cost P250,000 P300,000 P400,000
Expected income 50,000 54,000 96,000

Required:
A. Calculate the ROIs of the three investments.
B. What is the division manager's current ROI, computed by using responsibility accounting concepts?
C. Which of the three investments would be selected if the manager's focus is on Oxnard's divisional
 performance? Why?
D. If Kemp has an imputed interest charge of 22%, compute the residual income of investment no. 3. Is this
investment attractive from Oxnard's perspective? From Kemp's perspective? Why?

Answer:
A. No. 1: P50,000 ÷ P250,000 = 20%
No. 2: P54,000 ÷ P300,000 = 18%
No. 3: P96,000 ÷ P400,000 = 24%

B. Controllable profit margin (P320,000) ÷ asset investment (P1,280,000) = 25%

C. None, as all will lower the current ROI.

D. Residual income: P96,000 - (P400,000 x 22%) = P8,000

This investment is attractive from both Oxnard and Kemp's perspectives. The positive
residual income indicates that the investment income covers the imputed interest
charge.

PROBLEM 4

Deborah Lewis, general manager of the Northwest Division of Berkshire Enterprises, has significant authority over
pricing decisions as well as programs that involve cost reduction/control. The data that follow relate to upcoming
divisional operations:

Average invested capital: P15,000,000

Annual fixed costs: P3,900,000
Variable cost per unit: P80
Number of units expected to be sold: 120,000

Required:
A. Top management will promote Deborah if she can earn a 14% return on investment for the year. What
unit selling price should she establish to get her promotion?
B. Independent of part "A," assume the unit selling price is P132 and that Berkshire has a 16% imputed
interest charge. Top management will promote Deborah to corporate headquarters if her division can
generate P200,000 of residual income. If Deborah desires to move to corporate, what must the division
do to the amount of annual fixed costs incurred? Show your calculations.

Answer:
A. A 14% return on investment will require the Division to produce income of P2,100,000 (P15,000,000 x
14%). If X = selling price, then:
120,000X - (120,000 x P80) - P3,900,000 = P2,100,000
120,000X - P9,600,000 - P3,900,000 = P2,100,000
120,000X = P15,600,000
X = P130

B. If X = fixed cost, then:

[(P132 - P80) x 120,000] - X - (P15,000,000 x 16%) = P200,000
P6,240,000 - X - P2,400,000 = P200,000
X = P3,640,000

To achieve her promotion, Deborah must reduce fixed costs by P260,000 (P3,900,000 - P3,640,000).
MULTIPLE-CHOICE

1. The biggest challenge in making a decentralized organization function effectively is:

A. earning maximum profits through fair practices.
B. minimizing losses.
C. taking advantage of the specialized knowledge and skills of highly talented managers.
D. obtaining goal congruence among division managers.
E. developing an adequate budgetary control system.

2. What practice is present when divisional managers throughout an organization work together in an effort to
achieve the organization's goals?
A. Participatory management.
B. Goal attainment.
C. Goal congruence.
D. Centralization of objectives.
E. Negotiation by subordinates.

3. Consider the following statements about goal congruence:

I. Goal congruence is obtained when managers of subunits throughout an organization strive to achieve
the goals set by top management.
II. Managers are often more concerned about the performance of their own subunits rather than the
performance of the entire organization.
III. Achieving goal congruence in most organizations is relatively straightforward and easy to accomplish.

Which of the above statements is (are) true?

A. I only.
B. II only.
C. I and II.
D. II and III.
E. I, II, and III.

4. Which of the following performance measures is (are) used to evaluate the financial success or failure of
investment centers?
A. Residual income.
B. Return on investment.
C. Number of suppliers.
D. Economic value added.
E. All of the above measures are used except "C."

5. ROI is most appropriately used to evaluate the performance of:

A. cost center managers.
B. revenue center managers.
C. profit center managers.
D. investment center managers.
E. both profit center managers and investment center managers.

Answer: D LO: 2 Type: RC

6. Which of the following is not considered in the calculation of divisional ROI?

A. Divisional income.
B. Earnings velocity.
C. Capital turnover.
D. Sales margin.
E. Sales revenue.
 7. Which of the following is the correct mathematical expression for return on investment?
A. Sales margin ÷ capital turnover.
B. Sales margin + capital turnover.
C. Sales margin - capital turnover.
D. Sales margin x capital turnover.
E. Capital turnover ÷ sales margin.

8. The ROI calculation will indicate:

A. the percentage of each sales dollar that is invested in assets.
B. the sales dollars generated from each dollar of income.
C. how effectively a company used its invested capital.
D. the invested capital generated from each dollar of income.
E. the overall quality of a company's earnings.

9. A company's sales margin:

A. must, by definition, be greater than the firm's net sales.
B. has basically the same meaning as the term "contribution margin."
C. is computed by dividing sales revenue into income.
D. is computed by dividing income into sales revenue.
E. shows the sales dollars generated from each dollar of income.

10. Which of the following is the correct mathematical expression to derive a company's capital turnover?
A. Sales revenue ÷ invested capital.
B. Contribution margin ÷ invested capital.
C. Income ÷ invested capital.
D. Invested capital ÷ sales revenue
E. Invested capital ÷ income

11. Capital turnover shows:

A. the amount of income generated by each dollar of capital investment.
B. the number of sales dollars generated by each dollar of capital investment.
C. the amount of contribution margin generated by each dollar of capital investment.
D. the amount of capital investment generated by each sales dollar.
E. the amount of capital investment generated by each dollar of income.

12. Webster Company had sales revenue and operating expenses of P5,000,000 and P4,200,000, respectively, for
the year just ended. If invested capital amounted to P6,000,000, the firm's ROI was:
A. 13.33%.
B. 83.33%.
C. 120.00%.
D. 750.00%.
E. some other figure.

13. Zang Enterprises had a sales margin of 7%, sales of P5,000,000, and invested capital of P4,000,000. The
company's ROI was:
A. 5.60%.
B. 8.75%.
C. 11.43%.
D. 17.86%.
14. Mission, Inc., reported a return on investment of 12%, a capital turnover of 5, and income of P180,000. On
the basis of this information, the company's invested capital was:
A. P300,000.
B. P900,000.
C. P1,500,000.
D. P7,500,000.

15. The information that follows relates to Katz Corporation:

Sales margin: 7.5%

Capital turnover: 2
Invested capital: P20,000,000

On the basis of this information, the company's sales revenue is:

A. P1,500,000.
B. P3,000,000.
C. P10,000,000.
D. P40,000,000.

16. A division's return on investment may be improved by increasing:

A. cost of goods sold and expenses.
B. sales margin and cost of capital.
C. sales revenue and cost of capital.
D. capital turnover or sales margin.

17. All of the following actions will increase ROI except:

A. an increase in sales revenues.
B. a decrease in operating expenses.
C. a decrease in a company's invested capital.
D. a decrease in the number of units sold.

18. Which of the following is used in the calculation of both return on investment and residual income?
A. Total stockholders' equity.
B. Retained earnings.
C. Invested capital.
D. Total liabilities.

19. Consider the following statements about residual income:

I. Residual income incorporates a firm's cost of acquiring investment capital.

II. Residual income is a percentage measure, not a dollar measure.
III. If used correctly, residual income may result in division managers making decisions that are in their
own best interest and not in the best interest of the entire firm.

Which of the above statements is (are) true?

A. I only.
B. II only.
C. I and II.
D. II and III.

20. The basic idea behind residual income is to have a division maximize its:
A. earnings per share.
B. income in excess of a corporate imputed interest charge.
C. cost of capital.
 D. cash flows.

21. Sunrise Corporation has a return on investment of 15%. A Sunrise division, which currently has a 13% ROI
and P750,000 of residual income, is contemplating a massive new investment that will (1) reduce divisional
ROI and (2) produce P120,000 of residual income. If Sunrise strives for goal congruence, the investment:
A. should not be acquired because it reduces divisional ROI.
B. should not be acquired because it produces P120,000 of residual income.
C. should not be acquired because the division's ROI is less than the corporate ROI before the investment is
considered.
D. should be acquired because it produces P120,000 of residual income for the division.
E. should be acquired because after the acquisition, the division's ROI and residual income are both
positive numbers.

22. The Fitzhugh Division of General Enterprises has a negative residual income of P540,000. Fitzhugh's
management is contemplating an investment opportunity that will reduce this negative amount to P400,000.
The investment:
A. should be pursued because it is attractive from both the divisional and corporate perspectives.
B. should be pursued because it is attractive from the divisional perspective although not from the corporate
perspective.
C. should be pursued because it is attractive from the corporate perspective although not from the divisional
perspective.
D. should not be pursued because it is unattractive from both the divisional and corporate perspectives.
E. should not be pursued because it is unattractive from the divisional perspective although it is attractive
from the corporate perspective.

23. The Magellan Division of Global Corporation, which has income of P250,000 and an asset investment of
P1,562,500, is studying an investment opportunity that will cost P450,000 and yield a profit of P67,500.
Assuming that Global uses an imputed interest charge of 14%, would the investment be attractive to:

1—Divisional management if ROI is used to evaluate divisional performance?

2—Divisional management if residual income (RI) is used to evaluate divisional performance?
3—The management of Global Corporation?

Attractive to Attractive to Attractive

Magellan: ROI Magellan: RI to Global
A. Yes Yes Yes
B. Yes No No
C. Yes No Yes
D. No Yes Yes
E. No Yes No

24. The Georgia Division of Carter Companies currently reports a profit of P3.4 million. Divisional invested
capital totals P12.5 million; the imputed interest rate is 14%. On the basis of this information, Georgia's
residual income is:
A. P476,000.
B. P1,274,000.
C. P1,650,000.
D. P1,750,000.

25. The following information relates to the Mountain Division of Adler Enterprises:

Income for the period just ended: P1,500,000

Invested capital: P12,000,000

If the firm has an imputed interest rate of 11%, Mountain's residual income would be:
 A. P165,000.
B. P180,000.
C. P187,500.
D. some other dollar amount.

26. Extron Division reported a residual income of P200,000 for the year just ended. The division had
P8,000,000 of invested capital and P1,000,000 of income. On the basis of this information, the imputed
interest rate was:
A. 2.5%.
B. 10.0%.
C. 12.5%.
D. 20.0%.

27. Barber Corporation uses an imputed interest rate of 13% in the calculation of residual income. Division X,
which is part of Barber, had invested capital of P1,200,000 and an ROI of 16%. On the basis of this
information, X's residual income was:
A. P24,960.
B. P36,000.
C. P156,000.
D. P192,000.

Use the following to answer questions 28-31:

The following information pertains to Bingo Concrete:

Sales revenue P1,500,000

Gross margin 600,000
Income 90,000
Invested capital 450,000

The company's imputed interest rate is 8%.

28. The capital turnover is:

A. 3.33.
B. 5.00.
C. 16.67.
D. 20.00.

29. The sales margin is:

A. 6%.
B. 15%.
C. 20%.
D. 30%.

30. The ROI is:

A. 6%.
B. 15%.
C. 20%.
D. 30%.

31. The residual income is:

A. P30,000.
B. P36,000.
C. P42,000.
 D. P54,000.

32. For the period just ended, United Corporation's Delta Division reported profit of P31.9 million and invested
capital of P220 million. Assuming an imputed interest rate of 12%, which of the following choices correctly
denotes Delta's return on investment (ROI) and residual income?
Return on Residual
Investment Income
A. 12.0% P(5.5) million
B. 12.0% P5.5 million
C. 14.5% P(5.5) million
D. 14.5% P5.5 million
E. 14.5% P26.4 million

33. For the period just ended, Price Corporation's Ohio Division reported profit of P49 million and invested
capital of P350 million. Assuming an imputed interest rate of 16%, which of the following choices correctly
denotes Ohio's return on investment (ROI) and residual income?
Return on Residual
Investment Income
A. 14% P7 million
B. 14% P(7) million
C. 16% P7 million
D. P7 million 14%
E. None of the above choices shows both the correct ROI and residual income.

34. Which of the following elements is not used when calculating the weighted-average cost of capital?
A. Before-tax cost of debt capital.
B. After-tax cost of debt capital.
C. Cost of equity capital.
D. Market value of debt capital.
E. Market value of equity capital.

35. The following information relates to the Atlantic Division of Ocean Enterprises:

Interest rate on debt capital: 8%

Cost of equity capital: 12%
Market value of debt capital: P50 million
Market value of equity capital: P80 million
Income tax rate: 30%

On the basis of this information, Atlantic's weighted-average cost of capital is:

A. 7.3%.
B. 8.3%.
C. 9.5%.
D. 10.8%.

1. The market value of Glendale’s debt and equity capital totals P180 million, 80% of which is equity related.
An analysis conducted by the company’s finance department revealed a 7% after-tax cost of debt capital and
a 10% cost of equity capital. On the basis of this information, Glendale’s weighted-average cost of capital:
A. is 7.6%.
B. is 8.5%.
C. is 9.4%.
D. cannot be determined based on the data presented because the cost of debt capital must be stated on a
before-tax basis.
E. cannot be determined based on the data presented because the cost of equity capital must be stated on an
after-tax basis.
37. Which of the following measures of performance is, in part, based on the weighted-average cost of capital?
A. Return on investment.
B. Capital turnover.
C. Book value.
D. Economic value added (EVA).

38. Which of the following elements is not used in the calculation of economic value added for an investment
center?
A. An investment center's after-tax operating income.
B. An investment center's total assets.
C. An investment center's return on investment.
D. An investment center's current liabilities.

39. Carolina Corporation has an after-tax operating income of P3,200,000 and a 9% weighted-average cost of
capital. Assets total P7,000,000 and current liabilities total P1,800,000. On the basis of this information,
Carolina's economic value added is:
A. P2,408,000.
B. P2,732,000.
C. P3,668,000.
D. P3,992,000.

40. The following information relates to Houston, Inc.:

Total assets P9,000,000

After-tax operating income 1,500,000
Current liabilities 800,000

If the company has a 10% weighted-average cost of capital, its economic value added would be:
A. P(200,000).
B. P530,000.
C. P680,000.
D. P970,000.

41. Given that ROI measures performance over a period of time, invested capital would most appropriately be
figured by using:
A. beginning-of-year assets.
B. average assets.
C. end-of-year assets.
D. total assets.

42. When an organization allows divisional managers to be responsible for short-term loans and credit, the
division's invested capital should be measured by
A. total assets minus total liabilities.
B. average total assets minus average current liabilities.
C. average total assets minus average total liabilities.
D. average total liabilities minus average current assets.
43. Hayes Division has been stagnant over the past five years, neither growing nor contracting in size and
profitability. Investments in new property, plant, and equipment have been minimal. Would the division's
use of total assets (valued at net book value) when measuring ROI result in (1) using numbers that are
consistent with those on the balance sheet and (2) a rising ROI over time?
Consistent with Numbers Produce a Rising Return on
on the Balance Sheet? Investment Over Time?
A. Yes Yes
B. Yes No
C. No Yes
D. No No

44. The income calculation for a division manager's ROI should be based on:
A. divisional contribution margin.
B. profit margin controllable by the division manager.
C. profit margin traceable to the division.
D. divisional income before interest and taxes.
E. divisional net income.

45. To partially eliminate the problems that are associated with the short-term focus of return on investment,
residual income, and EVA, the performance of a division's major investments is commonly evaluated
through:
A. postaudits.
B. sensitivity analysis.
C. performance operating plans.
D. horizontal analysis.
E. segmented reporting.

TRANSFER PRICING

PROBLEM 1

Bronx Corporation's Gauge Division manufactures and sells product no. 24, which is used in refrigeration
systems. Per-unit variable manufacturing and selling costs amount to P20 and P5, respectively. The
Division can sell this item to external domestic customers for P36 or, alternatively, transfer the product to the
company's Refrigeration Division. Refrigeration is currently purchasing a similar unit from Taiwan for P33.
Assume use of the general transfer-pricing rule.

Required:
A. What is the most that the Refrigeration Division would be willing to pay the Gauge Division for one
unit?
B. If Gauge had excess capacity, what transfer price would the Division's management set?
C. If Gauge had no excess capacity, what transfer price would the Division's management set?
D. Repeat part "C," assuming that Gauge was able to reduce the variable cost of internal transfers by P4 per
unit.

Answer:

A. Refrigeration would be willing to pay a maximum of P33, its current outside purchase price.

B. The general rule holds that the transfer price be set at the sum of outlay cost and opportunity cost. Thus,
(P20 + P5) + P0 = P25.

C. In this case, the transfer price would amount to P36: (P20 + P5) + (P36 - P20 - P5).
 D. The transfer price would be P32: (P20 + P5 - P4) + (P36 - P20 - P5).

PROBLEM 2

Gamma Division of Vaughn Corporation produces electric motors, 20% of which are sold to Vaughan's Omega
Division and 80% to outside customers. Vaughn treats its divisions as profit centers and allows division managers to
choose whether to sell to or buy from internal divisions. Corporate policy requires that all interdivisional sales and
purchases be transferred at variable cost. Gamma Division's estimated sales and standard cost data for the year ended
December 31, based on a capacity of 60,000 units, are as follows:

Omega Outsiders
Sales P 660,000 P5,760,000
Less: Variable costs 660,000 2,640,000
Contribution margin P ---- P3,120,000
Less: Fixed costs 175,000 900,000
Operating income (loss) P (175,000) P2,220,000

Unit sales 12,000 48,000

Gamma has an opportunity to sell the 12,000 units shown above to an outside customer at P80 per unit. Omega can
purchase the units it needs from an outside supplier for P92 each.

Required:
A. Assuming that Gamma desires to maximize operating income, should it take on the new customer and
discontinue sales to Omega? Why? (Note: Answer this question from Gamma's perspective.)
B. Assume that Vaughn allows division managers to negotiate transfer prices. The managers agreed on a
tentative price of P80 per unit, to be reduced by an equal sharing of the additional Gamma income that
results from the sale to Omega of 12,000 motors at P80 per unit. On the basis of this information,
compute the company's new transfer price.

Answer:
A. Yes. Gamma is currently selling motors to Omega at a transfer price of P55 per unit (P660,000 ÷ 12,000
units). A price of P80 to the new customer will increase Gamma Division's operating income by
P300,000 [(P80 - P55) x 12,000 units].

B. The additional operating income to Gamma is P300,000 [(P80 - P55) x 12,000 units]. Splitting this
amount equally results in a new transfer price of P67.50, calculated as follows:

Transfer price before reduction P80.00

Less: Omega's per-unit share of additional income
[(P300,000 x 50%) ÷ 12,000 units] 12.50
New transfer price P67.50

PROBLEM 2

Sonoma Corporation is a multi-divisional company whose managers have been delegated full profit responsibility
and complete autonomy to accept or reject transfers from other divisions. Division X produces 2,000 units of a
subassembly that has a ready market. One of these subassemblies is currently used by Division Y for each final
product manufactured, the latter of which is sold to outsiders for P1,600. Y's sales during the current period
amounted to 2,000 completed units. Division X charges Division Y the P1,100 market price for the subassembly;
variable costs are P850 and P600 for Divisions X and Y, respectively.

The manager of Division Y feels that X should transfer the subassembly at a lower price because Y is currently
unable to make a profit.
Required:
A. Calculate the contribution margins (total dollars and per unit) of Divisions X and Y, as well as the
company as a whole, if transfers are made at market price.
B. Assume that conditions have changed and X can sell only 1,000 units in the market at P900 per unit.
From the company's perspective, should X transfer all 2,000 units to Y or sell 1,000 in the market and
transfer the remainder? Note: Y's sales would decrease to 1,000 units if the latter alternative is pursued.

Answer:
A. Division X Division Y Company
Sales at P1,600 P 3,200,000 P 3,200,000
Transfers at P1,100 P 2,200,000 (2,200,000)
Less: Variable costs
at P850 (1,700,000)
at P600 (1,200,000) (2,900,000)
Contribution margin P 500,000 P (200,000) P 300,000

Unit contribution margin P 250 P (100) P 150

B. Alternative no. 1: Transfer 2,000 units to Division Y:

Company sales (2,000 x P1,600) P3,200,000

Less: Variable costs [2,000 x P850) + (2,000 x P600)] 2,900,000
Contribution margin P 300,000

Alternative no. 2: Sell 1,000 units in the open market and transfer 1,000 units to Y:

Company sales [(1,000 x P900) + (1,000 x P1,600)] P2,500,000

Less: Variable costs [(2,000 x P850) + (1,000 x P600)] 2,300,000
Contribution margin P 200,000

Division X should transfer all 2,000 units to Division Y to produce an additional

P100,000 (P300,000 - P200,000) of contribution margin.

PROBLEM 3

Kendall Corporation has two divisions: Phoenix and Tucson. Phoenix currently sells a condenser to manufacturers
of cooling systems for P520 per unit. Variable costs amount to P380, and demand for this product currently exceeds
the division's ability to supply the marketplace.

Kendall is considering another use for the condenser, namely, integration into an enhanced refrigeration system that
would be made by Tucson. Related information about the refrigeration system follows.

Selling price of refrigeration system: P1,285

Additional variable manufacturing costs required: P820
Transfer price of condenser: P490

Top management is anxious to introduce the refrigeration system; however, unless the transfer is made, an
introduction will not be possible because of the difficulty of obtaining condensers in the quality and quantity desired.
The company uses responsibility accounting and ROI in measuring divisional performance, and awards bonuses to
divisional management.
Required:
A. How would Phoenix's divisional manager likely react to the decision to transfer condensers to Tucson?
Show computations to support your answer.
B. How would Tucson's divisional management likely react to the P490 transfer price? Show computations
to support your answer.
C. Assume that a lower transfer price is desired. What parties should be involved in setting the new price?
D. From a contribution margin perspective, does Kendall benefit more if it sells the condensers externally or
transfers the condensers to Tucson? By how much?

Answer:
A. The Phoenix divisional manager will likely be opposed to the transfer. Currently, the
division is selling all the units it produces at P520 each. With transfers taking place at
P490, Phoenix will suffer a P30 drop in sales revenue and profit on each unit that is sent to
Tucson.

B. Although Tucson is receiving a P30 "price break" on each unit purchased from Phoenix, the
P490 transfer price would probably be deemed too high. The reason: Tucson will lose P25
on each refrigeration system produced and sold.

Sales revenue P1,285

Less: Variable manufacturing costs P820
Transfer price paid to Phoenix 490 1,310
Income (loss) P (25)

C. Kendall uses a responsibility accounting system, awarding bonuses based on divisional

performance. The two divisional managers (or their representatives) should negotiate a
mutually agreeable price.

D. Kendall would benefit more if it sells the condenser externally. Observe that the transfer
price is ignored in this evaluation—one that looks at the firm as a whole.

Produce Produce Condenser;

Condenser; Sell Transfer; Sell
Externally Refrigeration System
Sales revenue P520 P1,285
Less: Variable cost
P380; P380 + P820 380 1,200
Contribution margin P140 P 85

PROBLEM 4

Walker, Inc., has a Pennsylvania-based division that produces electronic components, with a very strong domestic
market for circuit no. 222. The variable production cost is P140, and the division can sell its entire output for P190.
Walker is subject to a 30% income tax rate.

Alternatively, the Pennsylvania division can ship the circuit to a division that is located in Mississippi, to be used in
the manufacture of a global positioning system (GPS). Information about the global positioning system and
Mississippi's costs follow.

Selling price: P380

Circuit shipping and handling fees to Mississippi: P10
Labor, overhead, and additional material costs of GPS: P120
Required:
A. Assume that the transfer price for the circuit was P160. How would Pennsylvania's divisional manager
likely react to a corporate decision to transfer the circuits to Mississippi? Why?
B. Calculate Pennsylvania income, Mississippi income, and income for the company as a whole if the
transfer took place at P160 per circuit.
C. Assuming that transfers took place at a price higher than P160, would the revised price increase,
decrease, or have no effect on Walker's income? Briefly explain.
D. Assume that Walker moved its GPS production facility to a division located in Germany, which is
subject to a 45% tax rate. The transfer took place at P180. Shipping fees (absorbed by the overseas
division) doubled to P20; the German division paid an import duty equal to 10% of the transfer price;
and labor, overhead, and additional material costs were P150 per GPS. If the German selling price of the
GPS amounted to P450, calculate Pennsylvania income, German income, and income for Walker as a
whole.
E. Suppose that U.S. and German tax authorities allowed some discretion in how transfer prices were set.
Given the difference in tax rates, should Walker attempt to generate the majority of its income in
Pennsylvania or Germany? Why?

Answer:

A. The manager would be unhappy, as the division is being forced to take a "hit" of P30 per circuit (P190
vs. P160).

B. Pennsylvania: P160 - P140 = P20; P20 - (P20 x 30%) = P14

Mississippi: P380 - P10 - P120 - P160 = P90; P90 - (P90 x 30%) = P63
Walker, Inc.: P14 + P63 = P77

C. Walker's income is unaffected, as the transfer price is a wash between the divisions. In other words,
Pennsylvania's revenue is offset by Mississippi's cost.

D. Pennsylvania: P180 - P140 = P40; P40 - (P40 x 30%) = P28

Germany: P450 - P20 - P150 - P180 - (P180 x 10%) = P82; P82 - (P82 x 45%) = P45.10
Walker, Inc.: P28.00 + P45.10 = P73.10

E. Tax rates are lower in the U.S. than in Germany (30% vs. 45%). Thus, Walker would benefit if it
generated the majority of its income in Pennsylvania.

MULTIPLE-CHOICE

1. The amounts charged for goods and services exchanged between two divisions are known as:
A. opportunity costs.
B. transfer prices.
C. standard variable costs.
D. residual prices.
E. target prices.

2. Nevada, Inc., has two divisions, one located in Las Vegas and the other located in Reno. Las Vegas sells
selected goods to Reno for use in various end-products. Assuming that the transfer prices set by Las Vegas do
not influence the decisions made by the two divisions, which of the following correctly describes the impact of
the transfer prices on divisional profits and overall company profit?
Las Vegas Profit Reno Profit Nevada Profit
A. Affected Affected Affected
B. Affected Affected Not affected
C. Affected Not affected Affected
 D. Not affected Not affected Affected
E. Not affected Not affected Not affected

3. Thurmond, Inc., has two divisions, one located in New York and the other located in Arizona. New York sells a
specialized circuit to Arizona and just recently raised the circuit’s transfer price. This price hike had no effect
on the volume of circuits transferred nor on Arizona’s option of acquiring the circuit from either New York or
from an external supplier. On the basis of this information, which of the following statements is most correct?
A. The profit reported by New York will increase and the profit reported by Arizona will decrease.
B. The profit reported by New York will increase, the profit reported by Arizona will decrease, and
Thurmond’s profit will be unaffected.
C. The profit reported by New York will decrease, the profit reported by Arizona will increase, and
Thurmond’s profit will be unaffected.
D. The profit reported by New York will increase and the profit reported by Arizona will increase.
E. The profit reported by New York and the profit reported by Arizona will be unaffected.

4. Which of the following describes the goal that should be pursued when setting transfer prices?
A. Maximize profits of the buying division.
B. Maximize profits of the selling division.
C. Allow top management to become actively involved when calculating the proper dollar amounts.
D. Establish incentives for autonomous division managers to make decisions that are in the overall
organization's best interests (i.e., goal congruence).
E. Minimize opportunity costs.

5. A general calculation method for transfer prices that achieves goal congruence begins with the additional outlay
cost per unit incurred because goods are transformed and then
A. adds the opportunity cost per unit to the organization because of the transfer.
B. subtracts the opportunity cost per unit to the organization because of the transfer.
C. adds the sunk cost per unit to the organization because of the transfer.
D. subtracts the sunk cost per unit to the organization because of the transfer.
E. adds the sales revenue per unit to the organization because of the transfer.

6. Suddath Corporation has no excess capacity. If the firm desires to implement the general transfer-pricing rule,
opportunity cost would be equal to:
A. zero.
B. the direct expenses incurred in producing the goods.
C. the total difference in the cost of production between two divisions.
D. the contribution margin forgone from the lost external sale.
E. the summation of variable cost plus fixed cost.

7. Tulsa Corporation has excess capacity. If the firm desires to implement the general transfer-pricing rule,
opportunity cost would be equal to:
A. zero.
B. the direct expenses incurred in producing the goods.
C. the total difference in the cost of production between two divisions.
D. the contribution margin forgone from the lost external sale.
E. the summation of variable cost plus fixed cost.

8. McKenna's Florida Division is currently purchasing a part from an outside supplier. The company's Alabama
Division, which has excess capacity, makes and sells this part for external customers at a variable cost of P22
and a selling price of P34. If Alabama begins sales to Florida, it (1) will use the general transfer-pricing rule
and (2) will be able to reduce variable cost on internal transfers by P4. If sales to outsiders will not be affected,
Alabama would establish a transfer price of:
A. P18.
B. P22.
C. P30.
 D. P34.
E. some other amount.

9. AutoTech's Northern Division is currently purchasing a part from an outside supplier. The company's Southern
Division, which has no excess capacity, makes and sells this part for external customers at a variable cost of P19
and a selling price of P31. If Southern begins sales to Northern, it (1) will use the general transfer-pricing rule
and (2) will be able to reduce variable cost on internal transfers by P3. On the basis of this information,
Southern would establish a transfer price of:
A. P16.
B. P19.
C. P28.
D. P31.

Use the following to answer questions 10-12:

Laissez Faire has two divisions: the Cologne Division and the Bottle Division. The Bottle Division produces
containers that can be used by the Cologne Division. The Bottle Division's variable manufacturing cost is P2,
shipping cost is P0.10, and the external sales price is P3. No shipping costs are incurred on sales to the Cologne
Division, and the Cologne Division can purchase similar containers in the external market for P2.60.

10. The Bottle Division has sufficient capacity to meet all external market demands in addition to meeting the
demands of the Cologne Division. Using the general rule, the transfer price from the Bottle Division to the
Cologne Division would be:
A. P2.00.
B. P2.10.
C. P2.60.
D. P2.90.
E. P3.00.

11. Assume the Bottle Division has no excess capacity and could sell everything it produced externally. Using the
general rule, the transfer price from the Bottle Division to the Cologne Division would be:
A. P2.00.
B. P2.10.
C. P2.60.
D. P2.90.
E. P3.00.

12. The maximum amount the Cologne Division would be willing to pay for each bottle transferred would be:
A. P2.00.
B. P2.10.
C. P2.60.
D. P2.90.
E. P3.00.

13. Transfer prices can be based on:

A. variable cost.
B. full cost.
C. an external market price.
D. a negotiated settlement between the buying and selling divisions.
E. all of the above.

14. Which of the following transfer-pricing methods can lead to dysfunctional decision-making behavior by
managers?
A. Variable cost.
 B. Full cost.
C. External market price.
D. A professionally negotiated, amicable settlement between the buying and selling divisions.

15. The Pro Division of Custom Industries is in need of a particular service. The service can be obtained from
another division of Custom at "cost," with cost defined as the summation of variable cost (P9) and fixed cost
(P3). Alternatively, Pro can secure the service from a source external to Custom for P10. Which of the
following statements is true?
A. Pro should compare P10 vs. P3 in deciding where to acquire the service.
B. Pro should compare P10 vs. P9 in deciding where to acquire the service.
C. Pro should compare P10 vs. P12 in deciding where to acquire the service.
D. From Custom's perspective, the proper decision is reached by comparing P10 vs. P9.
E. Both "C" and "D" are true.

16. Division A transfers item no. 78 to Division B. Consider the following situations:

1—A is located in Texas and B is located in California.

2—A is located in Texas and B is located in Mexico.

Assuming that item no. 78 is unavailable in the open market, which of the following choices correctly depicts
the probable importance of federal income taxes when determining the transfer price that is established for
item no. 78?
Situation 1 Situation 2
A. Important Important
B. Important Not important
C. Not important Important
D. Not important Not important
E. It is not possible to judge based on the information presented.

17. Division A transfers a profitable subassembly to Division B, where it is assembled into a final product. A is
located in a European country that has a high tax rate; B is located in an Asian country that has a low tax rate.
Ideally, (1) what type of before-tax income should each division report from the transfer and (2) what type of
transfer price should be set for the subassembly?
Division A Division B Transfer
Income Income Price
A. Low Low Low
B. Low High Low
C. Low High High
D. High Low High
E. High High Low

18. Consider the following statements about transfer pricing:

I. Income taxes and import duties are an important consideration when setting a transfer price for
companies that pursue international commerce.
II. Transfer prices cannot be used by organizations in the service industry.
III. Transfer prices are totally cost-based in nature, not market-based.

Which of the above statements is (are) true?

A. I only.
B. II only.
C. I and II.
D. II and III.
E. I, II, and III.
WORKING CAPITAL MANAGEMENT

1. Other things held constant, which of the following will cause an increase in working capital?
a. Cash is used to buy marketable securities.
b. A cash dividend is declared and paid.
c. Merchandise is sold at a profit, but the sale is on credit.
d. Long-term bonds are retired with the proceeds of a preferred stock issue.
e. Missing inventory is written off against retained earnings.

2. Which of the following statements is most correct?

a. The current ratio is calculated as net working capital divided by current liabilities.
b. Gross working capital represents current assets used in operations.
c. Net working capital is defined as current assets minus current liabilities.
d. Statements b and c are correct.
e. Statements a, b, and c are correct.

3. Helena Furnishings wants to sharply reduce its cash conversion cycle. Which of the following steps would reduce its cash
conversion cycle?
a. The company increases its average inventory without increasing its sales.
b. The company reduces its DSO.
c. The company starts paying its bills sooner, which reduces its average accounts payable without reducing its sales.
d. Statements a and b are correct.
e. All of the statements above are correct.

4. Which of the following statements is most correct?

a. A cash management system that minimizes collections float and maximizes disbursement float is better than one with
higher collections float and lower disbursement float.
b. A cash management system that maximizes collections float and minimizes disbursement float is better than one with
lower collections float and higher disbursement float.
c. The use of a lockbox is designed to minimize cash theft losses. If the cost of the lockbox is less than theft losses saved,
then the lockbox should be installed.
d. Other things held constant, a firm will need a smaller line of credit if it can arrange to pay its bills by the 5th of each
month than if its bills come due uniformly during the month.

5. Which of the following statements about current asset management is most correct?
a. A positive net float means that a company has more cash available for its use than the amount shown in the company’s
books.
b. Use of a lockbox reduces the possibility that petty cash will be lost.
c. Depreciation has an impact on the cash budget.
d. Statements a and c are correct.
e. All of the statements above are correct.

6. Which of the following statements is most correct?

a. A good cash management system would minimize disbursement float and maximize collections float.
b. If a firm begins to use a well-designed lockbox system, this will reduce its customers’ net float.
c. 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.
d. If a firm can get its customers to permit it to pay by wire transfers rather than having to write checks, this will increase its
net float and thus reduce its required cash balances.
e. 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.

7. A lockbox plan is
a. A method for safe-keeping of marketable securities.
b. Used to identify inventory safety stocks.
c. A system for slowing down the collection of checks written by a firm.
d. A system for speeding up a firm’s collections of checks received.
8. Which of the following is not a situation that might lead a firm to hold marketable securities?
a. The firm has purchased a fixed asset that will require a large write-off of depreciable expense.
b. The firm must meet a known financial commitment, such as financing an ongoing construction project.
c. The firm must finance seasonal operations.
d. The firm has just sold long-term securities and has not yet invested the proceeds in earning assets.
e. None of the statements above is correct. (All of the situations might lead the firm to hold marketable securities.)

9. Analyzing days sales outstanding (DSO) and the aging schedule are two common methods for monitoring receivables. However,
they can provide erroneous signals to credit managers when
a. Customers’ payments patterns are changing.
b. Sales fluctuate seasonally.
c. Some customers take the discount and others do not.
d. Sales are relatively constant, either seasonally or cyclically.

10. Which of the following is not commonly regarded as being a credit policy variable?
a. Credit period.
b. Collection policy.
c. Credit standards.
d. Cash discounts.
e. All of the statements above are credit policy variables.

11. If easing a firm’s credit policy lengthens the collection period and results in a worsening of the aging schedule, then why do firms
take such actions?
a. It normally stimulates sales.
b. To meet competitive pressures.
c. To increase the firm’s deferral period for payables.
d. Statements a and b are correct.

12. In the text, the “red-line method” refers to

a. The policy of drawing a red line around certain neighborhoods on a map and then refusing to sell on credit to people who
live within those areas.
b. Restrictions imposed by companies that insure credit risks.
c. The use in Dun & Bradstreet’s reports of a red line to show the maximum amount of credit that should be extended to a
given customer; companies using this limit when they screen customers’ orders are said to be using the “red-line
method.”
d. A method of controlling inventories by drawing a red line on the inside of a bin.
e. A method of controlling receivables by drawing a red line on invoices of companies that are expected to pay late.

13. Which of the following might be attributed to efficient inventory management?

a. High inventory turnover ratio.
b. Low incidence of production schedule disruptions.
c. High total assets turnover.
d. Statements a and c are correct.
e. All of the statements above are correct.

14. Which of the following statements is most correct?

a. Working capital management involves both setting working capital policy and carrying out that policy in day-to-day
operations.
b. The aging schedule is the cycle in which a firm purchases inventory, sells goods on credit, and then collects accounts
receivable.
c. The best and most comprehensive picture of a firm’s liquidity position is shown by its cash budget, which forecasts cash
inflows and outflows.
d. Statements a, b, and c are correct.
e. Statements a and c are correct.

15. Ignoring cost and other effects on the firm, which of the following measures would tend to reduce the cash conversion cycle?
a. Maintain the level of receivables as sales decrease.
b. Buy more raw materials to take advantage of price breaks.
c. Take discounts when offered.
d. Forgo discounts that are currently being taken.
e. Offer a longer deferral period to customers.
16. Which of the following actions are likely to reduce the length of a company’s cash conversion cycle?
a. Adopting a new inventory system that reduces the inventory conversion period.
b. Reducing the average days sales outstanding (DSO) on its accounts receivable.
c. Reducing the amount of time the company takes to pay its suppliers.
d. Statements a and b are correct.
e. All of the statements above are correct.

17. Which of the following statements is most correct?

a. The cash balances of most firms consist of transactions, compensating, precautionary, and speculative balances. The total
desired cash balance can be determined by calculating the amount needed for each purpose and then summing them
together.
b. The easier a firm’s access to borrowed funds the higher its precautionary balances will be, in order to protect against
sudden increases in interest rates.
c. For some firms, holding highly liquid marketable securities is a substitute for holding cash because the marketable
securities accomplish the same objective as cash.
d. Firms today are more likely to rely on cash than on reserve borrowing power or marketable securities for speculative
purposes because of the need to move quickly.

18. A lockbox plan is most beneficial to firms that

a. Send payables over a wide geographic area.
b. Have widely disbursed manufacturing facilities.
c. Have a large marketable securities account to protect.
d. Hold inventories at many different sites.
e. Make collections over a wide geographic area

19. Which of the following statements is most correct?

a. Poor synchronization of cash flows that results in high cash management costs can be partially offset by increasing
disbursement float and decreasing collections float.
b. The size of a firm’s net float is primarily a function of its natural cash flow synchronization and how it clears its checks.
c. Lockbox systems are used mainly for security purposes as well as to decrease the firm’s net float.
d. If a firm can speed up its collections and slow down its disbursements, it will be able to reduce its net float.
e. A firm practicing good cash management and making use of positive net float will bring its check book balance as close
to zero as possible, but must never generate a negative book balance.

20. Which of the following statements is most correct?

a. Compensating balance requirements apply only to businesses, not to individuals.
b. Compensating balances are essentially costless to most firms, because those firms would normally have such funds on
hand to meet transactions needs anyway.
c. If the required compensating balance is larger than the transactions balance the firm would ordinarily hold, then the
effective cost of any loan requiring such a balance is increased.
d. Banks are prohibited from earning interest on the funds they force businesses to keep as compensating balances.

21. Which of the following statements is most correct?

a. A firm that makes 90 percent of its sales on credit and 10 percent for cash is growing at a rate of 10 percent annually. If
the firm maintains stable growth it will also be able to maintain its accounts receivable at its current level, since the 10
percent cash sales can be used to manage the 10 percent growth rate.
b. In managing a firm’s accounts receivable it is possible to increase credit sales per day yet still keep accounts receivable
fairly steady if the firm can shorten the length of its collection period.
c. If a firm has a large percentage of accounts over 30 days old, it is a sign that the firm’s receivables management needs to
be reviewed and improved.
d. Since receivables and payables both result from sales transactions, a firm with a high receivables-to-sales ratio should
also have a high payables-to-sales ratio.

22. Which of the following statements is most correct?

a. If credit sales as a percentage of a firm’s total sales increases, and the volume of credit sales also increases, then the firm’s
accounts receivable will automatically increase.
b. It is possible for a firm to overstate profits by offering very lenient credit terms that encourage additional sales to
financially “weak” firms. A major disadvantage of such a policy is that it is likely to increase uncollectible accounts.
c. A firm with excess production capacity and relatively low variable costs would not be inclined to extend more liberal
credit terms to its customers than a firm with similar costs that is operating close to capacity.
d. Firms use seasonal dating primarily to decrease their DSO.
 e. Seasonal dating with terms 2/15, net 30 days, with April 1 dating, means that if the original sale took place on February
1st, the customer can take the discount up until March 15th, but must pay the net invoice amount by April 1st.

23. Which of the following statements is most correct?

a. If a firm’s volume of credit sales declines then its DSO will also decline.
b. If a firm changes its credit terms from 1/20, net 40 days, to 2/10, net 60 days, the impact on sales can’t be determined
because the increase in the discount is offset by the longer net terms, which tends to reduce sales.
c. The DSO of a firm with seasonal sales can vary. While the sales per day figure is usually based on the total annual sales,
the accounts receivable balance will be high or low depending on the season.
d. An aging schedule is used to determine what portion of customers pay cash and what portion buy on credit.
e. Aging schedules can be constructed from the summary data provided in the firm’s financial statements.

24. Which of the following statements is most correct?

a. Other things held constant, the higher a firm’s days sales outstanding (DSO), the better its credit department.
b. If a firm that sells on terms of net 30 changes its policy and begins offering all customers terms of 2/10, net 30, and if no
change in sales volume occurs, then the firm’s DSO will probably increase.
c. If a firm sells on terms of 2/10, net 30, and its DSO is 30 days, then its aging schedule would probably show some past
due accounts.
d. Statements a and c are correct.
e. None of the statements above is correct.

25. Which of the following statements is incorrect about working capital policy?
a. A company may hold a relatively large amount of cash if it anticipates uncertain sales levels in the coming year.
b. Credit policy has an impact on working capital since it has the potential to influence sales levels and the speed with which
cash is collected.
c. The cash budget is useful in determining future financing needs.
d. Holding minimal levels of inventory can reduce inventory carrying costs and cannot lead to any adverse effects on
profitability.
e. Managing working capital levels is important to the financial staff since it influences financing decisions and overall
profitability of the firm.

26. Which of the following statements is most correct?

a. Depreciation is included in the estimate of cash flows (Cash flow = Net income + Depreciation), so depreciation is set
forth on a separate line in the cash budget.
b. If cash inflows and cash outflows occur on a regular basis, such as the situation where inflows from collections occur in
equal amounts each day and most payments are made regularly on the 10th of each month, then it is not necessary to use
a daily cash budget. A cash budget prepared at the end of the month will suffice.
c. Lockboxes are more important for fast food retailers such as McDonald’s, which deal primarily with cash, than for
manufacturers such as Xerox, which are generally paid by check.
d. Statements b and c are correct.
e. None of the statements above is correct.

27. Jarrett Enterprises is considering whether to pursue a restricted or relaxed current asset investment policy. The firm’s annual sales
are P400,000; its fixed assets are P100,000; debt and equity are each 50 percent of total assets. EBIT is P36,000, the interest rate
on the firm’s debt is 10 percent, and the firm’s tax rate is 40 percent. With a restricted policy, current assets will be 15 percent of
sales. Under a relaxed policy, current assets will be 25 percent of sales. What is the difference in the projected ROEs between the
restricted and relaxed policies?
a. 0.0%
b. 6.2%
c. 5.4%
d. 1.6%

28. On average, a firm sells P2,000,000 in merchandise a month. It keeps inventory equal to one-half of its monthly sales on hand at
all times. If the firm analyzes its accounts using a 365-day year, what is the firm’s inventory conversion period?
a. 365.0 days
b. 182.5 days
c. 30.3 days
d. 15.2 days
 29. Biondi Manufacturing Company (BMC) has an average accounts receivable balance of P1,250,000, an average inventory balance
of P1,750,000, and an average accounts payable balance of P800,000. Its annual sales are P12,000,000 and its cost of goods sold
represents 80 percent of annual sales. Assume there are 365 days in a year. What is BMC’s cash conversion cycle?
a. 84.15 days
b. 53.23 days
c. 72.28 days
d. 100.55 days
e. 60.83 days
.
30. Porta Stadium Inc. has annual sales of P80,000,000 and keeps average inventory of P20,000,000. On average, the firm has
accounts receivable of P16,000,000. The firm buys all raw materials on credit, its trade credit terms are net 35 days, and it pays
on time. The firm’s managers are searching for ways to shorten the cash conversion cycle. If sales can be maintained at existing
levels but inventory can be lowered by P4,000,000 and accounts receivable lowered by P2,000,000, what will be the net change in
the cash conversion cycle? Use a 365-day year. Round to the closest whole day.
a. +105 days
b. -105 days
c. +27 days
d. -27 days
e. -3 days

31. You have recently been hired to improve the performance of Multiplex Corporation, which has been experiencing a severe cash
shortage. As one part of your analysis, you want to determine the firm’s cash conversion cycle. Using the following information
and a 365-day year, what is your estimate of the firm’s current cash conversion cycle?

 Current inventory = P120,000.

 Annual sales = P600,000.
 Accounts receivable = P157,808.
 Accounts payable = P25,000.
 Total annual purchases = P365,000.
 Purchases credit terms: net 30 days.
 Receivables credit terms: net 50 days.

a. 49 days
b. 193 days
c. 100 days
d. 168 days
e. 144 days

32. Kolan Inc. has annual sales of P36,500,000 (P100,000 a day on a 365-day basis). On average, the company has P12,000,000 in
inventory and P8,000,000 in accounts receivable. The company is looking for ways to shorten its cash conversion cycle, which is
calculated on a 365-day basis. Its CFO has proposed new policies that would result in a 20 percent reduction in both average
inventories and accounts receivables. The company anticipates that these policies will also reduce sales by 10 percent. Accounts
payable will remain unchanged. What effect would these policies have on the company’s cash conversion cycle?

a. -40 days
b. -22 days
c. -13 days
d. +22 days
e. +40 days

33. Gaston Piston Corp. has annual sales of P50,735,000 and maintains an average inventory level of P15,012,000. The average
accounts receivable balance outstanding is P10,008,000. The company makes all purchases on credit and has always paid on the
30th day. The company is now going to take full advantage of trade credit and pay its suppliers on the 40th day. If sales can be
maintained at existing levels but inventory can be lowered by P1,946,000 and accounts receivable lowered by P1,946,000, what
will be the net change in the cash conversion cycle? (Assume there are 365 days in the year.)

a. -14.0 days
b. -18.8 days
c. -28.0 days
d. -25.6 days
 e. -38.0 days

34. Allen Brothers is interested in increasing its free cash flow (which it hopes will result in a higher EVA and stock price). The
company’s goal is to generate P180 million of free cash flow over the upcoming year. Allen’s CFO has made the following
projections for the upcoming year:

 EBIT is projected to be P850 million.

 Gross capital expenditures are expected to total P360 million, and its depreciation expense is expected to be P120 million.
Thus, its net capital expenditures are expected to total P240 million.
 The firm’s tax rate is 40 percent.

The company forecasts that there will be no change in its cash and marketable securities, nor will there be any changes in notes
payable or accrued liabilities. Which of the following will enable the company to achieve its goal of generating P180 million in
free cash flow?

a. Accounts receivable increase P470 million, inventory increases P230 million, and accounts payable increase P790
million.
b. Accounts receivable increase P470 million, inventory increases P230 million, and accounts payable increase P610
million.
c. Accounts receivable decrease by P500 million, inventory increases by P480 million, and accounts payable decline by P80
million.
d. Accounts receivable decrease by P400 million, inventory increases by P480 million, and accounts payable increase by
P80 million.
e. Accounts receivable increase by P500 million, inventory increases by P100 million, and accounts payable decline by
P480 million.

35. Jordan Air Inc. has average inventory of P1,000,000. Its estimated annual sales are P10 million and the firm estimates its
receivables conversion period to be twice as long as its inventory conversion period. The firm pays its trade credit on time; its
terms are net 30 days. The firm wants to decrease its cash conversion cycle by 10 days. It believes that it can reduce its average
inventory to P863,000. Assume a 365-day year and that sales will not change. By how much must the firm also reduce its
accounts receivable to meet its goal of a 10-day reduction in its cash conversion cycle?

a. P 101,900
b. P1,000,000
c. P 136,986
d. P 333,520
e. P 0