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6 Aug 2018

Sheep Shank Farms Ltd is considering extending the credit period offered to customers from 30 to 60 days. It is expected that customers will continue to pay on the net date. The company currently generates $450,000 in credit sales per annum with associated variable costs of $345,000. The change in credit terms is expected to increase credit sales to $510,000. Bad-debt expense is anticipated to increase from 1% to 1.5% as a result of lengthening the credit period. The company’s required rate of return on equal-risk investments is 20%.

Required:

a What additional profit contribution from sales will be realised from the proposed change?

[ marks]

b What is the cost of the marginal investment in accounts receivable?

[ marks]

c What is the cost of the marginal bad debts?

[ marks]

d Do you recommend the proposed change in credit terms? Why or why not?

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Jamar Ferry
Jamar FerryLv2
8 Aug 2018

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Chuck’s Beer Distributing is considering changing its credit policy from “net 45” to “2/20, net 45”. The firm expects its average collection period to decrease by 12 days, and 40% of its customers to take the cash discount. Chuck’s current credit sales of $40 million are not expected to change if the firm offers the cash discount. The firm’s bad-debt loss ratio is expected to remain at 4% if it adopts the credit terms. Chuck’s variable cost ratio is 70%, and it is able to invest at a rate of 16%. The firm does not expect its inventory level to change as a result of its proposed change in credit terms.

Compute the funds released by the change in credit terms.

Compute the net impact the change in credit terms has on Chuck’s pre-tax profits.

Next Week’s Technology (NWT) is evaluating whether to change its credit terms from 2/10, net 30 to 3/10, net 30. At present, 50 percent of NWT’s sales are paid on Day 10, whereas, under the new terms, 60 percent of sales will be paid on Day 10. Regardless of the credit terms, half of the customers who do not take the discount are expected to pay on Day 30, whereas the remainder will pay 15 days late (no bad debts exist). But, as a result of the higher cash discount offered with the new terms, sales are expected to increase from $360,000 to $396,000 per year. NWT’s variable cost ratio is 80 percent and its cost of funds is 9 percent. All production costs are paid on the day of the sale. Should NWT change its credit terms?

On the 15th of December 2020, Great Moments (Pty) (Ltd) is planning its working capital
management for January 2021. Beginning January 2021, the predicted financial information is as
follows:
Item Value (R)
Inventory 4 550 000
Trade receivables 4 083 500
Trade payables 1 867 000
Overdraft 2 402 500
For 2020, the company expects to generate sales revenue worth R3.5-million. It sells all its
products on credit. The following are the monthly sales figures for the remaining months of the year,
and January 2021:
Month Sales Value (R)
November 2020 (actual) 2 708 750
December 2020 (predicted) 3 000 000
January 2021 (predicted) 3 500 000
Great Moments (Pty) (Ltd) provides you with the following information also:
• 40% profit margin policy;
• Offers 30 days credit and uses a 365-day year;
• 60% of its customers settle in the month after purchase;
• Remaining customers take an additional month of credit;
• Inventory is expected to increase by R522,500 during the month of January 2021;
• Plans to settle 70% of its trade payables in the month of January 2021 and the balance at the
end of February 2021;
• All the company’s suppliers require settlement within 30 days;
• Purchases on credit in the month of January 2021 are forecast as R2,500,000;
• Interest on overdraft worth R700,000 is due in January 2021;
• The finance manager forecast that January’s operating cash outflows to amount to
R1,465,000; and
• The finance manager informs you that Great Moments (Pty) (Ltd) has no cash and depends
on a bank overdraft. The overdraft is used to finance daily operations. The company has no
plans to raise long-term funds in the month of January 2021.
BBA2_FIN II_ASG_2021 © Regenesys Business School 5
You are required to:
a. Calculate:
i. Great Moments (Pty) Ltd’s cash operating cycle at the beginning of January 2021.
Round off days to nearest day. (6 marks)
ii. Forecast overdraft required at the end of January 2021. (18 marks)
iii. Great Moments (Pty) Ltd’s current ratios at the beginning and end of January 2021. (6
marks)
b. Appraise and recommend five ways or strategies to manage trade receivables you would
provide to the Great Moments (Pty) Ltd’s finance manager. (10 marks)

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