CA Inter P6 · Chapter 9
Management of Working Capital MCQs with Answers
9 multiple-choice questions on Management of Working Capital for CA Inter P6 Financial Management and Strategic Management. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
A manufacturer holds raw materials for 45 days, work-in-progress for 15 days and finished goods for 30 days. It allows customers 50 days' credit and receives 40 days' credit from suppliers. Its net operating cycle is:
- A) 100 days
- B) 140 days
- C) 90 days
- D) 180 days
Show answer & explanation
Answer: A) 100 days
Gross operating cycle = raw material + WIP + finished goods + receivables periods = 45 + 15 + 30 + 50 = 140 days. Net operating cycle = gross operating cycle - payables deferral period = 140 - 40 = 100 days. The figure 140 days is the gross cycle.
Question 2
Average raw material inventory is ₹ 3,00,000 and annual raw material consumption is ₹ 24,00,000. Assuming 360 days in a year, the raw material storage period is:
- A) 60 days
- B) 30 days
- C) 8 days
- D) 45 days
Show answer & explanation
Answer: D) 45 days
Raw material storage period = average raw material stock / (annual consumption / 360) = 3,00,000 / (24,00,000 / 360) = 3,00,000 / 6,666.67 = 45 days. The figure 8 is the number of times inventory turns over (24,00,000 / 3,00,000), not days.
Question 3
Ankur Ltd needs ₹ 72,00,000 cash during the year, spread evenly. The fixed cost of each conversion of marketable securities into cash is ₹ 150, and the interest rate on marketable securities is 10% per annum. Using the Baumol model, the optimum cash conversion size is closest to:
- A) ₹ 1,03,923
- B) ₹ 1,46,969
- C) ₹ 97,980
- D) ₹ 14,697
Show answer & explanation
Answer: B) ₹ 1,46,969
Baumol's model: C = √(2 x annual cash requirement x cost per transaction / interest rate) = √(2 x 72,00,000 x 150 / 0.10) = √21,600,000,000 = ₹ 1,46,969 (rounded to the nearest rupee). Leaving out the factor 2 gives about ₹ 1,03,923.
Question 4
Using the Miller-Orr model, a firm sets its lower cash limit at ₹ 50,000. The cost per transaction in marketable securities is ₹ 200, the variance of daily net cash flows is ₹ 40,00,000 (in rupees squared) and the daily interest rate is 0.03%. The return point is closest to:
- A) ₹ 62,599
- B) ₹ 68,899
- C) ₹ 37,798
- D) ₹ 87,798
Show answer & explanation
Answer: A) ₹ 62,599
Spread = 3 x [(3/4) x transaction cost x variance / daily interest rate]^(1/3) = 3 x [0.75 x 200 x 40,00,000 / 0.0003]^(1/3) = 3 x (2 x 10^12)^(1/3) = 3 x 12,599.2 = ₹ 37,798. Return point = lower limit + spread/3 = 50,000 + 12,599 = ₹ 62,599. The upper limit is 50,000 + spread = ₹ 87,798.
Question 5
A supplier offers credit terms of 2/10, net 40. Assuming 365 days in a year and using simple annualisation, the approximate annual cost of not taking the cash discount and paying on day 40 is:
- A) 24.33%
- B) 24.83%
- C) 18.62%
- D) 2.04%
Show answer & explanation
Answer: B) 24.83%
Paying on day 40 instead of day 10 gives 30 extra days of credit at a cost of 2% of the invoice, that is, ₹ 2 for the use of ₹ 98. Annual cost = (2/98) x (365/30) = 0.020408 x 12.1667 = 24.83%. Using the full 40 days as the credit period gives 18.62%, which is wrong because the discount is lost only for the extra 30 days.
Question 6
Ganga Ltd has credit sales of ₹ 60 lakh, an average collection period of 30 days and bad debts of 1% of sales. A relaxed credit policy would raise credit sales to ₹ 70 lakh, the collection period to 60 days and bad debts to 2% of sales. Variable costs are 75% of sales and fixed costs of ₹ 6 lakh a year will not change. The required return on investment in receivables is 12% per annum, and the investment in receivables is to be measured at total cost (variable cost plus fixed cost). Taking 360 days in a year, the net effect on annual profit of adopting the new policy is:
- A) Increase of ₹ 1,70,000
- B) Increase of ₹ 1,04,000
- C) Increase of ₹ 90,000
- D) Increase of ₹ 1,10,000
Show answer & explanation
Answer: B) Increase of ₹ 1,04,000
Total cost: present = 45 lakh + 6 lakh = ₹ 51 lakh; proposed = 52.5 lakh + 6 lakh = ₹ 58.5 lakh. Investment in receivables at total cost: present = 51,00,000 x 30/360 = ₹ 4,25,000; proposed = 58,50,000 x 60/360 = ₹ 9,75,000. Cost of funds at 12%: present ₹ 51,000, proposed ₹ 1,17,000, an increase of ₹ 66,000. Extra contribution = 10,00,000 x 25% = ₹ 2,50,000, and bad debts rise from ₹ 60,000 to ₹ 1,40,000 (+ ₹ 80,000). Net gain = 2,50,000 - 66,000 - 80,000 = ₹ 1,04,000. Valuing receivables at variable cost only gives ₹ 1,10,000, at sales value gives ₹ 90,000, and ignoring the cost of funds gives ₹ 1,70,000.
Question 7
Under a factoring arrangement 'with recourse', the risk of bad debts on the receivables assigned:
- A) Is shared equally between the factor and the customer
- B) Is borne by the client's bank under a letter of credit
- C) Passes fully to the factor, which cannot claim from the client
- D) Stays with the client firm, which must make good to the factor any amounts customers fail to pay
Show answer & explanation
Answer: D) Stays with the client firm, which must make good to the factor any amounts customers fail to pay
In recourse factoring, the factor provides finance and collection services, but the client keeps the credit risk and must reimburse the factor for bad debts. In non-recourse factoring, the factor absorbs bad debt losses and charges a higher fee.
Question 8
A firm finances all of its permanent current assets and part of its temporary (fluctuating) current assets with long-term funds, using short-term funds only for peak needs. This working capital financing policy is best described as:
- A) Aggressive approach
- B) Conservative approach
- C) Matching (hedging) approach
- D) Zero working capital approach
Show answer & explanation
Answer: B) Conservative approach
Under the conservative approach, long-term funds cover permanent working capital and part of the temporary requirement, which lowers liquidity risk but raises cost. The matching approach finances permanent needs with long-term funds and temporary needs with short-term funds. The aggressive approach uses short-term funds even for part of the permanent requirement.
Question 9
In estimating working capital, a company expects annual cost of sales (excluding depreciation) of ₹ 48,00,000 and allows customers 1.5 months' credit. Receivables are to be valued at cost. The estimated investment in receivables is:
- A) ₹ 12,00,000
- B) ₹ 7,20,000
- C) ₹ 6,00,000
- D) ₹ 4,00,000
Show answer & explanation
Answer: C) ₹ 6,00,000
Receivables at cost = annual cost of sales x credit period / 12 = ₹ 48,00,000 x 1.5 / 12 = ₹ 6,00,000. Valuing at cost (excluding depreciation, which is a non-cash item) measures the funds actually tied up, since the profit element is not a cash investment. The figure ₹ 4,00,000 covers only one month.