Name: CASTAÑEDA, Jelaena Mai Section: IHL

INSTRUCTIONS: Answer the following questions. Use green font color for your answers.

1. Certain liability and net worth items generally increase spontaneously with increase in
sales. Put a check by those items that typically increase spontaneously. Explain your
answer.

a. Accounts payable ✓ Accounts payable would

increase because an increase of
sales would mean the company
increased their inventory. It is
also most likely that they paid
the inventories on account.
b. Notes payable to banks Notes payable to banks would
most likely not increase
spontaneously with increase in
sales because issuance of notes
payable is part of the financial
aspect of the company, and
they are only used as an
additional fund. Furthermore,
there is also a possibility that
the note was made before the
spontaneous increase. The
amount would still not change
then because it has already a
fixed amount.
c. Accrued wages ✓ Accrued wages would increase
because a company must have
increased their workers to
generate more sales.
d. Accrued taxes ✓ Since the amount of tax
depends on the amount of
sales, accrued taxes would
increase as sales increase.
e. Mortgage bonds Mortgage bonds would most
likely not increase
spontaneously with increase in
sales because, again, it is part of
 the financial aspect of the
company, and are usually used
as an additional fund. They are
also set at a fixed amount so it
cannot just change dramatically.
f. Common stock ✓ Common stock would increase
because share values depend on
the performance of the
company. Since the sales
increased, the value will also
increase.
g. Retained ✓ Retained earnings would most
likely increase since it is directly
related to sales. If the sales
increase, the earnings would
also increase.

2. Suppose a firm makes the following policy changes. If the change means that extent,
nonspontaneous financial requirement (AFN) will increase, indicate this situation with a
(+); indicate a decrease with a (-); and indicate an indeterminate or no effect with a (0).
Think in terms of the immediate, short-run effect on funds requirements. Explain your
answer.

a. The dividend payout ratio is increased. + By giving more to the

shareholders, less will remain
in the company. Therefore a
need of AFN will increase.
b. The firm contracts to buy, rather than - By just purchasing the
make, certain components used in its products, less fixed assets
products. (machineries) are needed.
Therefore, less AFN is
needed.
c. The firm decides to pay all suppliers on - Since there is a discount, less
delivery, rather than after a 30-day delay, AFN is needed.
to take advantage of discounts for rapid
payment.
d. The firm begins to sell on credit + By having more receivables
(previously all sales had been on a cash instead of cash on hand,
basis) additional funding is needed
for the company to survive.
e. The firm’s profit margin is eroded by 0 No effect on AFN because
increased competition; sales remain sales remain steady.
steady.
f. Advertising expenditures are stepped up. + Additional expenditures
would mean the need to
increase additional funds
g. A decision is made to substitute long-term 0 No effect on AFN because
mortgage bonds for short-term bank the loans substituted the
loans. bond.
h. The firm begins to pay employees on a 0 No effect on AFN because
weekly basis (previously it had paid them salary rate is still the same
at the end of each month) regardless when it is paid.

3. What benefits can be derived from breakeven analysis? What are some problems with
breakeven analysis?
a. It gives the analyst an idea how many units it will take before the start-up
reaches profitability.
b. The main problem of the analysis is it is very unrealistic. Cost can change
depending on its demand or buying power, and, as for the sales, not all products
can be sold, so it depends on the business’s strategy how long will it actually take
to sell that many units. It is also harder to calculate for the break-even if the
start-up sells more than one product.
4. What data are required to construct a breakeven graph?
a. The data required are fixed costs, variable costs, and selling price.
5. Explain how profits or losses will be magnified for a firm with high operating leverage as
opposed to a firm with lower operating leverage.
a. A company with a high operating leverage would mean most of the operations
cost are financed by debt. Losses will be magnified because even if the company
weren’t able to sell any of their products, they have to pay their large debt
resulting in bankruptcy. If they managed to finance the high leverage with extra
precaution, on the other hand, their profits will be magnified greatly.
6. Explain how profits or losses will be magnified for a firm with high financial leverage as
opposed to a firm with lower financial leverage.
a. A company with a high financial leverage would mean most of the assets are
paid with debt instead of equity. Profits will be magnified if financed correctly. If
not, the company will suffer a huge loss.
7. Discuss the relationship between a firm’s degree of total leverage and its perceived risk.
a. The higher the degree of total leverage, the higher are its risks. That is because,
again, most of the company’s assets are financed by debt instead of equity.
8. What would be the effect of each of the following events on a firm’s breakeven point?
Indicate the effect in the space provided with a (+) for an increase, a (-) for a decrease,
and a (0) for no effect. When answering this question, assume that everything except
the change indicated is held constant. Explain your answer.

a. An increase in the sales price - By increasing the sales

price, the less units it will
 take to cover the fixed
expenses.
b. A reduction in variable labor costs - By reducing the variable
costs, the less units it will
take to cover the fixed
expenses.
c. A decrease in fixed operating costs - By decreasing the fixed
costs, less units will be
needed to cover it.
d. Issuing new bonds 0 Bonds are not a variable in
the breakeven analysis, so
it does not affect it.

9. Assume that a firm is developing its long-run financial plan. What period should this plan
cover – one month, six months, one year, three years, five years, or some other period?
Justify your answer.
a. From its name, long-run or long-term financial plan is a plan that should at least
cover three to five years. It can’t be less than three years because it will lose its
essence of being a long-term plan. Because it covers a long period, long-term
plans only project estimates and not exact figures that short-term plans can
offer.
10. What is cash budget? For what purpose should cash budget be created?
a. The cash budget is the schedule of summarized expected cash inflows and cash
outflows. Its main purpose is to schedule and establish the amount of cash that
goes in and out of the business.
11. Why is a cash budget important even when the firm has plenty of cash in the bank?
a. It is important to create a cash budget even if the firm has plenty of cash
because there is still a possibility that they will experience financial problems. To
avoid that problem, it is always advised to plan ahead and create a budget.
12. Describe the relationships between accounts payable, inventories, accounts receivable,
and the cash account by tracing the effects on these accounts of a product
manufactured and sold by a company. Start with the purchase of raw materials and
conclude with the collection of the sale of the product.
a. It first starts at the purchase of raw materials. Because the business collected
raw materials, the inventories will increase. The business may opt to pay them
through cash or account. If they pay with cash, the cash account will decrease. If
they pay on account, the accounts payable account, a liability, will increase.
b. As for the selling portion of the product, the inventory will decrease. The
customer may opt to pay through cash or account. If through cash, the cash
account will increase. If on account, the accounts receivable account, an asset,
will increase.
13. Describe the cash conversion cycle. How can a financial manager use knowledge of the
cash conversion cycle to better manage the firm’s working capital?
 a. The cash conversion cycle states the number of days it takes for the investment
to be recovered. In other words, it states when the company will gain cash from
their investment made on credit. The cash conversion cycle includes the Average
Collection Period, Average Age of Inventory, and Average Payment Period.
b. Since the cash conversion cycle can provide insights on how long it will take for
the receivables and payables to convert into cash, the financial manager can use
this as a basis if the firm is financially doing well. For example, if the conversion
period is too long, then it may be time to improve the financial plan.
14. What are the advantages of matching the maturities of assets and liabilities? What are
the advantages?
a. The advantages include lesser risks and tighter financial control. It can also
maintain a high efficiency level with regards to the working capital. That is
because by matching the maturities,
15. What are two principal reasons for holding cash?
a. The two principal reasons are transactions and compensating balances. First,
cash is needed to meet the daily transactions of the business. Second, cash is
needed to compensate the cost incurred by a bank for a loan.
16. What are the elements of a firm’s credit policy? To what extent can firms set their own
credit policies as opposed to having to accept policies that are dictated by “the
competition”?
a. The elements are credit standards, terms of credit (credit period and cash
discount), and collection policy. The firms can set their own credit policies if the
firm is doing better than its competition with regards to its flexibility, working
capital, and cost of funds.
17. What are aging schedules, and how can the credit manager use them to manage
accounts receivable more effectively?
a. Aging schedules present the due dates of the company’s account receivables.
The credit manager can use them to see if their customers are paying on time.
18. Describe the three classification of inventory and indicate the purpose of holding each
type.
a. The three types are the raw materials, which are the basic materials to produce
the products, the work in progress inventory, which are the products that are
partially complete, and the finished goods inventory, which are the products that
are ready for sale.
b. The main purpose of having each type is to be ready with the selling, the only
difference between the three is how long it will take before it reaches to the
customer. The finished goods, since they are ready for sale, are the first ones to
be sold. While the finished goods are generating revenue, the work in progress
inventory should start finishing up the last production process so that they can
be sold after. The raw materials on hand should now also undergo its production
process to create the next set of work in progress inventory.
19. “Every firm should use the EOQ model to determine the optimal level of inventory to
maintain.” Discuss the accuracy of this statement with respect to the form of the EOQ
model.
a. The statement is quite accurate with respect to the model of EOQ. Since the goal
of the model is to minimize the cost of inventory, it allows the company to
maximize its available resources, and therefore, generate more profit. The only
problem is there is still a possibility that sales will decline or increase. By strictly
following the EOQ model, you are assuming that demand will stay the same, and
you are not prepared for the unforeseen circumstances.