Test 3: Management of Working Capital: answer key

Question 1 · 2 marks · Management of Working Capital · medium

Scenario. Bharat Renewables Ltd manufactures industrial solar-inverter modules for domestic and export markets. The finance director is reviewing the treasury department's cash requirements for May 2027 and the annual cash management policy. The company follows a 360-day financial year and maintains surplus funds in short-term marketable securities. Corporate financial information (₹ crore): Equity share capital: 6.00 Retained earnings: 2.00 10% secured term loan: 4.00 Projected EBIT: 2.40 Corporate tax rate: 25% Equity beta: 1.10 Risk-free rate: 6.50% Market risk premium: 6.00% Forecast annual operating cash flow: 2.80 The operating cycle comprises raw-material storage of 30 days, WIP holding of 15 days, finished-goods storage of 20 days, debtor collection of 35 days and supplier credit of 25 days, resulting in a net operating cycle of 75 days. The treasury department estimates predictable annual cash disbursements of ₹3,84,00,000. The fixed transaction cost of each transfer from marketable securities to the cash account is ₹1,500, and the annual yield on marketable securities is 8%. The following information relates to the May cash budget: Opening cash balance on 1 May: ₹18,00,000 Cash sales: ₹12,00,000 Collections from debtors: ₹28,00,000 Dividend received: ₹1,00,000 Payments to suppliers: ₹20,00,000 Wages and salaries: ₹7,00,000 Operating overheads: ₹5,00,000 Advance income tax: ₹4,00,000 Purchase of plant and equipment: ₹10,00,000 Debenture interest: ₹1,50,000 Minimum desired closing cash balance: ₹8,00,000 The finance manager follows the receipts and payments method for preparing the monthly cash budget. The Baumol model is separately applied to predictable annual disbursements. No other cash receipts or payments are anticipated. The company intends to invest any cash surplus above its minimum desired balance in marketable securities, while any deficit would be met through temporary borrowing.

Using William J. Baumol's Economic Order Quantity model for cash, calculate the optimum cash balance of Bharat Renewables Ltd.

1. ₹12,00,000 (correct answer)
2. ₹10,00,000
3. ₹14,00,000
4. ₹16,00,000

Answer: A — ₹12,00,000

Explanation. Baumol's formula is C = √[(2 × U × P)/S], where U is annual cash disbursement, P is transaction cost and S is annual opportunity cost. Substituting: C = √[(2 × ₹3,84,00,000 × ₹1,500)/0.08] = √₹1,44,00,00,00,000 = ₹12,00,000. Option b understates the balance through an incorrect interest-rate adjustment, while option d may arise from using monthly instead of annual cash requirements inconsistently.

Where it goes wrong. Using inconsistent time periods for annual cash disbursements and the annual opportunity cost, or incorrectly applying the yield percentage.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 2 · 2 marks · Management of Working Capital · medium

Based on the optimum cash balance calculated using Baumol's model, determine the approximate number of transfers from marketable securities required annually by Bharat Renewables Ltd.

1. 24 transfers
2. 32 transfers (correct answer)
3. 36 transfers
4. 40 transfers

Answer: B — 32 transfers

Explanation. Annual cash requirement = ₹3,84,00,000. Optimum cash conversion lot size = ₹12,00,000. Number of transfers = Annual cash requirement ÷ Optimum cash balance = ₹3,84,00,000 ÷ ₹12,00,000 = 32 transfers. Option a understates the frequency by using an unnecessarily high conversion lot, whereas option d overstates the frequency by using a lower conversion amount. Each transfer replenishes the cash account from marketable securities.

Where it goes wrong. Dividing annual cash disbursements by average cash balance instead of the optimum cash conversion lot size.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 3 · 2 marks · Management of Working Capital · hard

Calculate the annual total relevant cash management cost under Baumol's model for Bharat Renewables Ltd at the optimum cash balance. Consider both transaction cost and opportunity cost.

1. ₹72,000
2. ₹84,000
3. ₹96,000 (correct answer)
4. ₹1,20,000

Answer: C — ₹96,000

Explanation. Annual transaction cost = Number of transfers × Transaction cost = 32 × ₹1,500 = ₹48,000. Average cash balance = ₹12,00,000 ÷ 2 = ₹6,00,000. Annual opportunity cost = ₹6,00,000 × 8% = ₹48,000. Total relevant cost = ₹48,000 + ₹48,000 = ₹96,000. At the optimum balance, the two cost components are equal. Option b may omit an entire cost component, while option d overstates the annual transaction cost.

Where it goes wrong. Calculating only transaction cost or only opportunity cost instead of adding both components of total relevant cash management cost.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 4 · 2 marks · Management of Working Capital · hard

Determine the amount of surplus cash available for short-term investment in marketable securities at the end of May after maintaining the minimum desired cash balance.

1. ₹2,50,000
2. ₹3,00,000
3. ₹4,00,000
4. ₹3,50,000 (correct answer)

Answer: D — ₹3,50,000

Explanation. Total cash available = Opening balance ₹18,00,000 + Receipts ₹12,00,000 + ₹28,00,000 + ₹1,00,000 = ₹59,00,000. Total payments = ₹20,00,000 + ₹7,00,000 + ₹5,00,000 + ₹4,00,000 + ₹10,00,000 + ₹1,50,000 = ₹47,50,000. Closing cash = ₹11,50,000. Surplus above minimum cash = ₹11,50,000 − ₹8,00,000 = ₹3,50,000. Capital expenditure and interest are cash payments and must be included.

Where it goes wrong. Omitting capital expenditure, interest or advance tax from cash payments, or treating the minimum cash balance as an additional receipt.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 5 · 2 marks · Management of Working Capital · medium

Scenario. Zenith Power Systems Ltd manufactures high-capacity electrical control panels for industrial customers. The company operates through multiple production locations and experiences unpredictable daily cash receipts and payments. The treasury department has therefore proposed the implementation of a stochastic cash management system to avoid excessive idle balances while maintaining adequate liquidity. Corporate financial information (₹ crore): Equity share capital: 5.50 Retained earnings: 2.50 9.5% secured debentures: 4.00 Projected EBIT: 2.20 Corporate tax rate: 25% Equity beta: 0.95 Risk-free rate: 6.25% Market risk premium: 6.50% Forecast annual operating cash flow: 2.65 The company's operating cycle is as follows: Raw-material storage: 28 days Work-in-process holding: 14 days Finished-goods storage: 21 days Debtor collection: 35 days Supplier credit: 28 days The resulting net operating cycle is 70 days. Management believes that better treasury controls can reduce financing requirements without interrupting production or customer deliveries. The following parameters have been estimated for the Miller-Orr model: Minimum desired cash balance or lower limit (L): ₹20,000 Fixed transaction cost per transfer (F): ₹200 Variance of daily net cash flows: 2,88,000 (₹ squared) Daily opportunity cost of holding cash (i): 0.0002 The daily opportunity cost corresponds to an annual marketable-securities yield of 7.20%, assuming 360 days in a year. The company uses the generalised Miller-Orr formulation, in which the lower cash limit is specified by management rather than necessarily being zero. The treasury manager will transfer cash to marketable securities whenever the upper control limit is reached and replenish cash from marketable securities whenever the lower control limit is reached. When cash remains between the limits, no corrective transaction is undertaken. Transaction costs and interest rates are assumed constant during the assessment period.

Using the Miller-Orr cash management model and the stated lower cash limit, calculate the return point of Zenith Power Systems Ltd.

1. ₹26,000 (correct answer)
2. ₹24,000
3. ₹28,000
4. ₹30,000

Answer: A — ₹26,000

Explanation. The return point is Z = L + [3 × F × Variance/(4 × i)]^(1/3). Substituting the data: Z = ₹20,000 + [3 × ₹200 × 2,88,000/(4 × 0.0002)]^(1/3). The expression inside the cube root equals 2,16,00,00,00,000, whose cube root is ₹6,000. Therefore, Z = ₹20,000 + ₹6,000 = ₹26,000. Option b understates the adjustment, while option c overstates the cube-root component.

Where it goes wrong. Ignoring the specified lower cash limit or using a square root instead of the cube root in the Miller-Orr formula.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 6 · 2 marks · Management of Working Capital · hard

Determine the upper control limit of cash balance under the Miller-Orr model for Zenith Power Systems Ltd.

1. ₹32,000
2. ₹38,000 (correct answer)
3. ₹42,000
4. ₹46,000

Answer: B — ₹38,000

Explanation. The Miller-Orr upper control limit is H = 3Z − 2L. From the previous computation, Z = ₹26,000 and the lower limit L = ₹20,000. Therefore, H = 3 × ₹26,000 − 2 × ₹20,000 = ₹78,000 − ₹40,000 = ₹38,000. Option a may result from using an incorrect return point, while option c may arise from adding the lower limit rather than deducting twice its value.

Where it goes wrong. Confusing the upper limit formula with three times the return point alone and forgetting the subtraction of twice the lower limit.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 7 · 2 marks · Management of Working Capital · hard

If Zenith Power Systems Ltd's cash balance reaches the upper control limit, what amount should be transferred from its cash account into marketable securities under the Miller-Orr model?

1. ₹6,000
2. ₹10,000
3. ₹12,000 (correct answer)
4. ₹18,000

Answer: C — ₹12,000

Explanation. The cash balance is transferred from the upper control limit to the return point. The amount invested in marketable securities is H − Z. Substituting H = ₹38,000 and Z = ₹26,000, the transfer equals ₹38,000 − ₹26,000 = ₹12,000. The cash balance consequently returns to ₹26,000. Option a represents the difference between the return point and lower limit, while option d incorrectly uses the entire excess above the lower limit.

Where it goes wrong. Transferring the entire cash balance above the lower limit instead of the difference between the upper control limit and the return point.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 8 · 2 marks · Management of Working Capital · medium

When the cash balance of Zenith Power Systems Ltd reaches its lower control limit, calculate the amount that must be transferred from marketable securities to the cash account to restore the return point.

1. ₹4,000
2. ₹8,000
3. ₹10,000
4. ₹6,000 (correct answer)

Answer: D — ₹6,000

Explanation. When cash reaches the lower limit, it must be replenished to the return point. Required transfer = Z − L = ₹26,000 − ₹20,000 = ₹6,000. This amount is transferred from marketable securities into the cash account. Option a understates the deficit, while option c may arise from treating the upper and lower limits as equidistant from the return point. The Miller-Orr model does not require symmetric control limits.

Where it goes wrong. Using the upper control limit instead of the return point when determining the cash replenishment required at the lower limit.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 9 · 2 marks · Management of Working Capital · medium

Scenario. Aditya Automotive Ltd manufactures precision components for commercial vehicle manufacturers. It operates through regional distribution offices and receives substantial payments from customers located outside its headquarters city. Management is evaluating improvements in collections through concentration banking, lockbox processing and electronic funds transfer arrangements. Corporate financial information (₹ crore): Equity share capital: 7.00 Retained earnings: 2.50 10% term debt: 3.50 Projected EBIT: 3.00 Corporate tax rate: 25% Equity beta: 1.15 Risk-free rate: 6.50% Market risk premium: 6.00% Forecast annual operating cash flow: 3.40 The company's working-capital cycle consists of raw-material storage of 30 days, WIP holding of 12 days, finished-goods storage of 18 days, debtor collection of 42 days and supplier credit of 30 days. Management is particularly concerned about delays between receipt of customer cheques and their availability as cleared funds. The company currently receives 400 customer remittances each business day, with an average remittance value of ₹20,000. It operates for 300 business days in a year. A proposed regional lockbox arrangement is expected to eliminate two days of cheque-processing float. The bank proposes an incremental service fee of ₹10 for every cheque processed under the arrangement. The expected annual return on released funds is 12%. Separately, management is considering concentration banking through regional collection centres. Average daily regional collections under this alternative are ₹30,00,000. The arrangement is expected to reduce the period before funds become available by half a day. Its annual service and administration cost is ₹1,20,000, and the expected return on released funds is also 12%. Electronic funds transfer facilities are available for customer and supplier transactions. Management expects instant account updating and faster transfer of funds, but wishes to compare the economic benefits of each collection arrangement before implementation. All collection volumes and savings estimates are assumed to remain constant throughout the assessment period.

Calculate the average funds released through the proposed lockbox arrangement of Aditya Automotive Ltd by eliminating two days of cheque-processing float.

1. ₹1,60,00,000 (correct answer)
2. ₹80,00,000
3. ₹2,40,00,000
4. ₹3,20,00,000

Answer: A — ₹1,60,00,000

Explanation. Average daily collections = 400 remittances × ₹20,000 = ₹80,00,000. The lockbox arrangement eliminates two days of processing float. Therefore, funds released = ₹80,00,000 × 2 = ₹1,60,00,000. This represents the average funds that become available earlier because cheques are deposited by the bank without prior company processing. Option b reflects only one day's collections, while option c applies an incorrect average collection volume.

Where it goes wrong. Using the annual number of cheques instead of daily collections, or forgetting to multiply the daily collection amount by the number of float days eliminated.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 10 · 2 marks · Management of Working Capital · hard

Determine the annual investment income generated by the funds released through the lockbox arrangement, using the expected annual return of 12%.

1. ₹12,00,000
2. ₹19,20,000 (correct answer)
3. ₹16,00,000
4. ₹24,00,000

Answer: B — ₹19,20,000

Explanation. Funds released through the lockbox arrangement = ₹1,60,00,000. Annual investment income = Funds released × Annual return = ₹1,60,00,000 × 12% = ₹19,20,000. The released amount represents the average additional liquidity generated by eliminating the two-day processing delay. Option a incorrectly applies a lower return or a shorter release period, while option d overstates the investment base.

Where it goes wrong. Applying the annual return to only one day's collections or confusing annual investment income with the total value of remittances processed.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 11 · 2 marks · Management of Working Capital · hard

After accounting for the bank's incremental fee, calculate the annual net economic benefit of adopting the lockbox arrangement.

1. ₹4,80,000
2. ₹12,00,000
3. ₹7,20,000 (correct answer)
4. ₹9,60,000

Answer: C — ₹7,20,000

Explanation. Annual investment income = ₹19,20,000. Annual cheques processed = 400 × 300 = 1,20,000. Annual lockbox service fee = 1,20,000 × ₹10 = ₹12,00,000. Net annual economic benefit = ₹19,20,000 − ₹12,00,000 = ₹7,20,000. Since the incremental income exceeds the incremental bank charge, the arrangement is financially beneficial. Option b represents the service fee, not the net gain.

Where it goes wrong. Comparing the gross investment income with the bank fee without deducting the incremental operating cost of the collection arrangement.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 12 · 2 marks · Management of Working Capital · medium

Evaluate the annual net benefit of Aditya Automotive Ltd's proposed concentration banking arrangement using the regional collection data provided.

1. ₹30,000
2. ₹90,000
3. ₹1,20,000
4. ₹60,000 (correct answer)

Answer: D — ₹60,000

Explanation. Average daily collections are ₹30,00,000 and the reduction in the time before funds become available is 0.5 day. Funds released = ₹30,00,000 × 0.5 = ₹15,00,000. Annual return on released funds = ₹15,00,000 × 12% = ₹1,80,000. Net annual benefit = ₹1,80,000 − ₹1,20,000 = ₹60,000. The arrangement is financially worthwhile because the marginal income exceeds its operating cost.

Where it goes wrong. Multiplying daily collections by the annual number of working days instead of calculating the average float balance released.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 13 · 2 marks · Management of Working Capital · medium

Scenario. A company has projected sales for April, May and June of ₹40 lakh, ₹50 lakh and ₹60 lakh, respectively. Twenty per cent of sales are cash sales and the balance are credit sales. Of the credit sales, 75% are collected one month after sale and 25% two months after sale. Calculate the total cash receipts during June, including June cash sales. Assume no bad debts.

A company has projected sales for April, May and June of ₹40 lakh, ₹50 lakh and ₹60 lakh, respectively. Twenty per cent of sales are cash sales and the balance are credit sales. Of the credit sales, 75% are collected one month after sale and 25% two months after sale. Calculate the total cash receipts during June, including June cash sales. Assume no bad debts.

1. ₹46,00,000
2. ₹50,00,000 (correct answer)
3. ₹54,00,000
4. ₹58,00,000

Answer: B — ₹50,00,000

Explanation. June cash sales = ₹60 lakh × 20% = ₹12 lakh. May credit sales = ₹50 lakh × 80% = ₹40 lakh; 75% collected in June = ₹30 lakh. April credit sales = ₹40 lakh × 80% = ₹32 lakh; 25% collected in June = ₹8 lakh. Total June receipts = ₹12 lakh + ₹30 lakh + ₹8 lakh = ₹50 lakh. Option a omits a collection component, while option d incorrectly assumes all credit sales are collected immediately.

Where it goes wrong. Mixing up the collection month of credit sales or applying the collection percentages to total sales instead of credit sales.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 14 · 2 marks · Management of Working Capital · medium

Scenario. A manufacturing enterprise has predictable annual cash disbursements of ₹3,24,00,000. The fixed transaction cost of converting marketable securities into cash is ₹500 per transaction, and the annual opportunity cost of holding cash is 9%. Calculate the optimum cash balance using Baumol's model.

A manufacturing enterprise has predictable annual cash disbursements of ₹3,24,00,000. The fixed transaction cost of converting marketable securities into cash is ₹500 per transaction, and the annual opportunity cost of holding cash is 9%. Calculate the optimum cash balance using Baumol's model.

1. ₹5,00,000
2. ₹7,00,000
3. ₹6,00,000 (correct answer)
4. ₹8,00,000

Answer: C — ₹6,00,000

Explanation. Using C = √[(2 × U × P)/S], substitute U = ₹3,24,00,000, P = ₹500 and S = 0.09. C = √[(2 × ₹3,24,00,000 × ₹500)/0.09] = √₹3,60,00,00,00,000 = ₹6,00,000. The model identifies the cash balance at which carrying and transaction costs are minimised. Option a understates the optimum balance, while option d overstates it.

Where it goes wrong. Using the transaction cost as a percentage or applying the annual interest rate without converting it into decimal form.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 15 · 2 marks · Management of Working Capital · hard

Scenario. A company prepares its June cash budget using the following information: Opening cash balance: ₹5,00,000 April sales: ₹20,00,000 May sales: ₹25,00,000 June sales: ₹30,00,000 Cash sales: 25% of total sales Credit sales collection: 70% after one month and 30% after two months June payments to suppliers: ₹12,00,000 June wages: ₹3,00,000 June operating overheads: ₹2,00,000 June machinery purchase: ₹4,00,000 June interest payment: ₹50,000 June tax payment: ₹1,00,000 Minimum required cash balance: ₹6,00,000 Calculate the surplus available for temporary investment in marketable securities at the end of June.

A company prepares its June cash budget using the following information: Opening cash balance: ₹5,00,000 April sales: ₹20,00,000 May sales: ₹25,00,000 June sales: ₹30,00,000 Cash sales: 25% of total sales Credit sales collection: 70% after one month and 30% after two months June payments to suppliers: ₹12,00,000 June wages: ₹3,00,000 June operating overheads: ₹2,00,000 June machinery purchase: ₹4,00,000 June interest payment: ₹50,000 June tax payment: ₹1,00,000 Minimum required cash balance: ₹6,00,000 Calculate the surplus available for temporary investment in marketable securities at the end of June.

1. ₹1,12,500
2. ₹2,62,500
3. ₹1,50,000
4. ₹1,62,500 (correct answer)

Answer: D — ₹1,62,500

Explanation. June receipts = Cash sales ₹7,50,000 + 70% of May credit sales (₹18,75,000 × 70% = ₹13,12,500) + 30% of April credit sales (₹15,00,000 × 30% = ₹4,50,000) = ₹25,12,500. Total payments = ₹22,50,000. Closing cash = ₹5,00,000 + ₹25,12,500 − ₹22,50,000 = ₹7,62,500. Surplus = ₹7,62,500 − ₹6,00,000 = ₹1,62,500.

Where it goes wrong. Including current-month credit sales as immediate receipts or forgetting to deduct capital expenditure and periodic interest and tax payments.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 16 · 2 marks · Management of Working Capital · hard

Scenario. A company applies the Miller-Orr model with the following parameters: lower cash limit ₹12,000, fixed transaction cost ₹100, daily net cash flow variance ₹1,08,000 and daily opportunity cost 0.0003. Calculate the return point and upper control limit, respectively.

A company applies the Miller-Orr model with the following parameters: lower cash limit ₹12,000, fixed transaction cost ₹100, daily net cash flow variance ₹1,08,000 and daily opportunity cost 0.0003. Calculate the return point and upper control limit, respectively.

1. ₹15,000 and ₹21,000 (correct answer)
2. ₹18,000 and ₹30,000
3. ₹16,000 and ₹24,000
4. ₹14,000 and ₹18,000

Answer: A — ₹15,000 and ₹21,000

Explanation. Return point Z = L + [3Fσ²/(4i)]^(1/3). Substitution gives Z = ₹12,000 + [3 × 100 × 1,08,000/(4 × 0.0003)]^(1/3) = ₹12,000 + 3,000 = ₹15,000. Upper limit H = 3Z − 2L = 3 × ₹15,000 − 2 × ₹12,000 = ₹21,000. Option b incorrectly doubles the cube-root adjustment, while option c uses an incorrect lower limit or control-limit formula.

Where it goes wrong. Confusing the cube-root adjustment with the complete return point, or calculating the upper limit without subtracting twice the lower limit.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 17 · 2 marks · Management of Working Capital · hard

Scenario. A company reports profit after tax of ₹48 lakh. During the year, depreciation was ₹12 lakh, trade receivables increased by ₹5 lakh, inventory decreased by ₹4 lakh, trade creditors increased by ₹3 lakh and accrued operating expenses increased by ₹1 lakh. Using the adjusted income method, determine the estimated cash generated from operations before other investing and financing cash flows.

A company reports profit after tax of ₹48 lakh. During the year, depreciation was ₹12 lakh, trade receivables increased by ₹5 lakh, inventory decreased by ₹4 lakh, trade creditors increased by ₹3 lakh and accrued operating expenses increased by ₹1 lakh. Using the adjusted income method, determine the estimated cash generated from operations before other investing and financing cash flows.

1. ₹59,00,000
2. ₹63,00,000 (correct answer)
3. ₹65,00,000
4. ₹68,00,000

Answer: B — ₹63,00,000

Explanation. Start with profit after tax ₹48 lakh. Add non-cash depreciation ₹12 lakh. Deduct the increase in receivables ₹5 lakh because additional funds are blocked in debtors. Add the decrease in inventory ₹4 lakh, increase in creditors ₹3 lakh and increase in accrued expenses ₹1 lakh because these release or preserve cash. Operating cash generation = ₹48 + ₹12 − ₹5 + ₹4 + ₹3 + ₹1 = ₹63 lakh.

Where it goes wrong. Treating increases in receivables or inventory as cash inflows, or failing to add back depreciation as a non-cash expense.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 18 · 2 marks · Management of Working Capital · hard

Scenario. A manufacturer processes 500 customer cheques daily with an average value of ₹12,000 each. A proposed lockbox arrangement would eliminate two days of cheque-processing float. If the annual return on released funds is 10% and the company operates for 300 business days, determine the maximum incremental bank fee per cheque at which the arrangement would break even.

A manufacturer processes 500 customer cheques daily with an average value of ₹12,000 each. A proposed lockbox arrangement would eliminate two days of cheque-processing float. If the annual return on released funds is 10% and the company operates for 300 business days, determine the maximum incremental bank fee per cheque at which the arrangement would break even.

1. ₹6
2. ₹10
3. ₹8 (correct answer)
4. ₹12

Answer: C — ₹8

Explanation. Daily collections = 500 × ₹12,000 = ₹60,00,000. Funds released through two days of float reduction = ₹1,20,00,000. Annual investment income = ₹1,20,00,000 × 10% = ₹12,00,000. Annual cheques = 500 × 300 = 1,50,000. Break-even fee per cheque = ₹12,00,000 ÷ 1,50,000 = ₹8. A higher fee would make the arrangement uneconomical, assuming no other incremental benefits or costs.

Where it goes wrong. Dividing annual bank income by daily cheque volume instead of annual cheque volume, or calculating the released cash without accounting for the two-day reduction.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 19 · 2 marks · Management of Working Capital · hard

Scenario. A company receives average regional collections of ₹48,00,000 per day. By introducing concentration banking, the time between receipt of customer remittances and availability of spendable funds is expected to reduce by 0.75 day. Released funds earn 10% annually. The incremental annual service cost is ₹2,40,000. Calculate the annual net economic benefit.

A company receives average regional collections of ₹48,00,000 per day. By introducing concentration banking, the time between receipt of customer remittances and availability of spendable funds is expected to reduce by 0.75 day. Released funds earn 10% annually. The incremental annual service cost is ₹2,40,000. Calculate the annual net economic benefit.

1. ₹80,000
2. ₹1,00,000
3. ₹1,50,000
4. ₹1,20,000 (correct answer)

Answer: D — ₹1,20,000

Explanation. Funds released = Average daily collections × Reduction in float = ₹48,00,000 × 0.75 = ₹36,00,000. Annual income = ₹36,00,000 × 10% = ₹3,60,000. Net economic benefit = ₹3,60,000 − ₹2,40,000 = ₹1,20,000. Since the released balance represents an average liquidity benefit, it is multiplied by the annual return only once. Option b incorrectly uses an understated float reduction.

Where it goes wrong. Multiplying released average funds by the number of operating days again, or comparing gross income without deducting concentration banking expenses.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 20 · 2 marks · Management of Working Capital · hard

Scenario. A business processes 250 electronic customer collections daily, each averaging ₹40,000. Implementing an upgraded electronic funds transfer system is expected to reduce the time between customer payment initiation and availability of funds by 0.5 day. The released funds can earn 9% annually. The annual incremental system charge is ₹1,50,000. Determine the annual net financial benefit.

A business processes 250 electronic customer collections daily, each averaging ₹40,000. Implementing an upgraded electronic funds transfer system is expected to reduce the time between customer payment initiation and availability of funds by 0.5 day. The released funds can earn 9% annually. The annual incremental system charge is ₹1,50,000. Determine the annual net financial benefit.

1. ₹3,00,000 (correct answer)
2. ₹4,50,000
3. ₹5,00,000
4. ₹1,50,000

Answer: A — ₹3,00,000

Explanation. Daily collections = 250 × ₹40,000 = ₹1,00,00,000. The 0.5-day improvement releases ₹50,00,000. Annual investment income = ₹50,00,000 × 9% = ₹4,50,000. Deduct annual system charges of ₹1,50,000. Net financial benefit = ₹4,50,000 − ₹1,50,000 = ₹3,00,000. Option b is the gross income before system charges, while option d represents only the cost.

Where it goes wrong. Treating the accelerated collection benefit as annual cash revenue rather than an average balance whose return must be calculated and reduced by the system cost.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 21 · 2 marks · Management of Working Capital · hard

Scenario. A company's cash budget for June contains the following estimates: Opening cash balance: ₹9,00,000 Collections from debtors: ₹27,00,000 Cash proceeds from sale of old equipment: ₹2,00,000 Payments to suppliers: ₹14,00,000 Wages and salaries: ₹5,00,000 Operating overheads: ₹4,00,000 Interest payment: ₹1,00,000 Capital expenditure: ₹6,00,000 Income tax: ₹3,00,000 Minimum required cash balance: ₹8,00,000 Determine the temporary overdraft required at the end of June to maintain the minimum desired cash balance.

A company's cash budget for June contains the following estimates: Opening cash balance: ₹9,00,000 Collections from debtors: ₹27,00,000 Cash proceeds from sale of old equipment: ₹2,00,000 Payments to suppliers: ₹14,00,000 Wages and salaries: ₹5,00,000 Operating overheads: ₹4,00,000 Interest payment: ₹1,00,000 Capital expenditure: ₹6,00,000 Income tax: ₹3,00,000 Minimum required cash balance: ₹8,00,000 Determine the temporary overdraft required at the end of June to maintain the minimum desired cash balance.

1. ₹2,00,000
2. ₹3,00,000 (correct answer)
3. ₹5,00,000
4. ₹7,00,000

Answer: B — ₹3,00,000

Explanation. Available funds before payments = Opening cash ₹9,00,000 + Debtor collections ₹27,00,000 + Equipment sale proceeds ₹2,00,000 = ₹38,00,000. Total payments = ₹14,00,000 + ₹5,00,000 + ₹4,00,000 + ₹1,00,000 + ₹6,00,000 + ₹3,00,000 = ₹33,00,000. Closing cash before financing = ₹5,00,000. Required minimum is ₹8,00,000, so overdraft = ₹8,00,000 − ₹5,00,000 = ₹3,00,000.

Where it goes wrong. Omitting equipment-sale proceeds or failing to include capital expenditure, tax and interest as cash payments when calculating the overdraft requirement.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 22 · 2 marks · Management of Working Capital · hard

Scenario. A company has annual predictable cash disbursements of ₹4,05,00,000. The fixed cost of transferring marketable securities into cash is ₹1,000 per transaction, and the annual opportunity cost of holding cash is 10%. Using Baumol's model, calculate the annual total relevant cash management cost at the optimum cash balance.

A company has annual predictable cash disbursements of ₹4,05,00,000. The fixed cost of transferring marketable securities into cash is ₹1,000 per transaction, and the annual opportunity cost of holding cash is 10%. Using Baumol's model, calculate the annual total relevant cash management cost at the optimum cash balance.

1. ₹75,000
2. ₹85,000
3. ₹90,000 (correct answer)
4. ₹1,00,000

Answer: C — ₹90,000

Explanation. Optimum cash balance = √[(2 × ₹4,05,00,000 × ₹1,000)/0.10] = ₹9,00,000. Number of transactions = ₹4,05,00,000 ÷ ₹9,00,000 = 45. Transaction cost = 45 × ₹1,000 = ₹45,000. Average cash balance = ₹4,50,000; opportunity cost = ₹4,50,000 × 10% = ₹45,000. Total annual relevant cost = ₹45,000 + ₹45,000 = ₹90,000.

Where it goes wrong. Using the entire optimum cash conversion lot as average cash balance instead of half the lot, thereby overstating opportunity cost.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 23 · 2 marks · Management of Working Capital · hard

Scenario. A company originally calculates its Miller-Orr return point and upper limit using a lower limit of ₹12,000, transaction cost of ₹100, daily variance of ₹1,08,000 and daily opportunity cost of 0.0003. Subsequently, the variance of daily net cash flows increases to eight times the original amount, while the other parameters remain unchanged. Calculate the revised upper control limit.

A company originally calculates its Miller-Orr return point and upper limit using a lower limit of ₹12,000, transaction cost of ₹100, daily variance of ₹1,08,000 and daily opportunity cost of 0.0003. Subsequently, the variance of daily net cash flows increases to eight times the original amount, while the other parameters remain unchanged. Calculate the revised upper control limit.

1. ₹27,000
2. ₹28,000
3. ₹29,000
4. ₹30,000 (correct answer)

Answer: D — ₹30,000

Explanation. The original cube-root adjustment is ₹3,000, as 3 × ₹100 × ₹1,08,000 ÷ (4 × 0.0003) = 27,00,00,00,000, whose cube root is ₹3,000. If variance increases eightfold, the cube-root adjustment increases by the cube root of eight, i.e. two times. The revised adjustment is ₹6,000. Revised Z = ₹12,000 + ₹6,000 = ₹18,000. Revised H = 3 × ₹18,000 − 2 × ₹12,000 = ₹30,000.

Where it goes wrong. Increasing the return-point adjustment eightfold instead of recognising that the adjustment is proportional to the cube root of variance.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 24 · 2 marks · Management of Working Capital · hard

Scenario. A company receives average daily customer remittances of ₹70,00,000. A proposed lockbox arrangement is expected to reduce cheque-processing float by 1.5 days. The company earns 8% annually on released funds, while the incremental annual bank service charge is ₹5,00,000. Calculate the net annual benefit and determine whether implementation is economically justified.

A company receives average daily customer remittances of ₹70,00,000. A proposed lockbox arrangement is expected to reduce cheque-processing float by 1.5 days. The company earns 8% annually on released funds, while the incremental annual bank service charge is ₹5,00,000. Calculate the net annual benefit and determine whether implementation is economically justified.

1. ₹3,40,000; implementation is beneficial (correct answer)
2. ₹5,00,000; implementation is beneficial
3. ₹8,40,000; implementation is beneficial
4. ₹1,60,000; implementation is not beneficial

Answer: A — ₹3,40,000; implementation is beneficial

Explanation. Funds released = ₹70,00,000 × 1.5 = ₹1,05,00,000. Annual income on released funds = ₹1,05,00,000 × 8% = ₹8,40,000. Deduct the annual bank service charge of ₹5,00,000. Net benefit = ₹8,40,000 − ₹5,00,000 = ₹3,40,000. Since the marginal income generated exceeds the incremental operating cost, the lockbox arrangement is economically justified. Option c represents gross income rather than net benefit.

Where it goes wrong. Treating the gross investment return as the final benefit without deducting the cost of outsourced lockbox services.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 25 · 2 marks · Management of Working Capital · hard

Scenario. A company has prepared the following cash budget estimates for July: Opening cash balance: ₹12,00,000 Collections from debtors: ₹40,00,000 Cash sales: ₹8,00,000 Interest received: ₹50,000 Payments to suppliers: ₹25,00,000 Wages and salaries: ₹6,00,000 Operating overheads: ₹4,00,000 Purchase of equipment: ₹8,00,000 Interest paid: ₹1,00,000 Income tax paid: ₹2,00,000 Minimum desired cash balance: ₹10,00,000 Assuming all receipts and payments take place during July, determine the surplus cash available for temporary investment in marketable securities.

A company has prepared the following cash budget estimates for July: Opening cash balance: ₹12,00,000 Collections from debtors: ₹40,00,000 Cash sales: ₹8,00,000 Interest received: ₹50,000 Payments to suppliers: ₹25,00,000 Wages and salaries: ₹6,00,000 Operating overheads: ₹4,00,000 Purchase of equipment: ₹8,00,000 Interest paid: ₹1,00,000 Income tax paid: ₹2,00,000 Minimum desired cash balance: ₹10,00,000 Assuming all receipts and payments take place during July, determine the surplus cash available for temporary investment in marketable securities.

1. ₹3,50,000
2. ₹4,50,000 (correct answer)
3. ₹5,50,000
4. ₹6,50,000

Answer: B — ₹4,50,000

Explanation. Total available cash = Opening balance ₹12,00,000 + Debtor collections ₹40,00,000 + Cash sales ₹8,00,000 + Interest received ₹50,000 = ₹60,50,000. Total payments = ₹25,00,000 + ₹6,00,000 + ₹4,00,000 + ₹8,00,000 + ₹1,00,000 + ₹2,00,000 = ₹46,00,000. Closing cash = ₹14,50,000. Surplus available for temporary investment = ₹14,50,000 − ₹10,00,000 = ₹4,50,000.

Where it goes wrong. Failing to include the opening cash balance or treating the minimum desired cash balance as an additional cash payment rather than the amount that must remain after budgeting.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital