Tutorial 4 Jan 2023 Questions Chapter 3

CORPORATE FINANCE (UKFF 3013)
JANUARY 2023 TRIMESTER

TUTORIAL 4 (WEEK STARTING 20 FEB 2023)
SHORT TERM FINANCE AND
THE MANAGEMENT OF WORKING CAPITAL (CHAPTER 3)
QUESTION 1
Discuss briefly the factors which influence the formulation of working capital policy.
QUESTION 2
Discuss the key elements of a trade receivables management policy.
QUESTION 3
Williams Wholesalers Berhad currently asks its credit customers to pay by the end of
the month after the month of delivery. In practice, customers take rather longer to
pay – on average 70 days. Sales revenue amounts to RM4 million a year and bad
debts to RM20,000 a year.
It is planned to offer customers a cash discount of 2 per cent for payment within 30
days. Williams estimates that 50 per cent of customers will accept this facility but that
the remaining customers, who tend to be slow payers, will not pay until 80 days after
the sale. At present the business has an overdraft facility at an interest rate of 13 per
cent a year. If the plan goes ahead, bad debts will be reduced to RM10,000 a year
and there will be savings in credit administration expenses of RM6,000 a year.
Should Williams Wholesalers Berhad offer the new credit terms to customers?
SOLUTION
Step 1: Determine the reduction in trade receivables arising from the new policy.
Existing level of trade

receivables
New level of trade

receivables:
Reduction in trade
receivables
The costs and benefits of offering the discount can be set out as follows:
Cost of discount
Less
Interest saved on the

reduction in trade
receivables
Administration cost
saving
Cost of bad debts saved
1|Page
Net cost of policy
Comment
QUESTION 4
T Berhad has annual credit sales of RM4.5 million. Credit terms are 30 days, but its
management of trade receivables has been poor and the average collection period is
50 days, with 0.4 percent of sales resulting in bad debts.
A factor has offered to take over the task of debt administration and credit checking,
at an annual fee of 1 percent of credit sales. T Berhad estimates that it could save
RM35,000 per year in administrative costs as a result. Due to the efficiency of the
factor, the average collection period would fall to 30 days and bad debts would be
eliminated. The factor would advance 80 percent of invoiced debts at an annual
interest rate of 11 percent. T Berhad currently finances trade receivables from an
overdraft costing 10 percent per year.
Required:
If credit sales occur smoothly throughout the year, determine whether the factor’s
services should be accepted. Will accepting the services of the factor maximize
shareholders’ wealth?
SOLUTION
RM
Current level of trade
receivables
Under the factor, trade
receivables will fall to
Decrease in receivable
Interest saving from using
overdraft
The costs of the current policy are:

RM
Cost of financing current
receivables
Cost of bad debts
Cost of current policy
2|Page
The costs under the factor are:

RM
Costs under factor
Factor’s annual fee
Saved administrative cost
Net cost under factor
Comment
Alternative calculation- From the slides

RM
Interest saving
Decrease in bad debts
Admin cost saving
Factor Fee
Interest on advance
Saving using factor
QUESTION 5
The Finance director of M Berhad is trying to improve the company’s slack working
capital management. Although M’s trade terms require settlement with 30 days, its
customers take an average of 45 days to pay. In addition, out of total credit sales of
RM15 million per year, the company suffers bad debts of RM235,000 annually
Proposal: It has been suggested that the average settlement period should be
reduced if an early settlement discount were offered and the finance director is
considering a reduction of 1.5 per cent of the face value of invoice for payment within
30 days It is expected that 40 percent of customers would use the discount but that
the average time taken by the remaining customers would not be affected. It is also
expected that, if the new credit terms are introduced, bad debts will fall by RM60,000
per year and administration costs will fall by RM15,000 per year.
Required:
(a) If total sales are unchanged and if working capital is financed by an overdraft at
9 per cent per year, are the new credit terms of any benefit to M Berhad?
3|Page
SOLUTION
Current receivables
New level of receivables
Those taking discount
Those not taking discount
Change in level of
receivables - reduction
Finance savings on
receivables
Decrease in bad debts
(benefit)
Savings in administration
costs (benefit)
Total Benefits to the co
Cost of discount
Net benefit of proposal
Conclusion:
QUESTION 6
G Berhad, a manufacturer of steel toys, has annual sales of RM20 million. Cost of
goods sold is 70% of sales, and purchases are 65% of cost of goods sold. All the
sales and purchases are on credit. Assume a 360-day year, and G Berhad has the
following ratios:
Average Inventory Holding Period 45 days
Average Payment Period 30 days
Average Collection Period 25 days
Required:
Compute the Cash Conversion Cycle (CCC) of G Berhad and the amount of net
working capital invested in the CCC.
If G Berhad wishes to improve its working capital management, recommend FOUR
(4) strategies to improve its CCC.
4|Page
SOLUTION
(i) CCC = Inventory days + Trade receivable days – Trade payable days
Cash Conversion Cycle (CCC)

Investment in Inventory
Investment in Receivables
Investment in Payables
Amount invested in CCC
(ii)
Strategies to improve CCC:
QUESTION 7
K Berhad is an e-business which trades solely over the internet. In the last year the
company had sales of RM15 million. All sales were on 30 days’ credit to commercial
customers.
Extracts from the company’s most recent statement of financial position relating to
working capital are as follows:
RM’000
Trade receivables 2,466
Trade payables 2,220
Overdraft 3,000
In order to encourage customers to pay on time, K Berhad proposes introducing an
early settlement discount of 1% for payment within 30 days, while increasing its
normal credit period to 45 days. It is expected that, on average, 50% of customers
will take the discount and pay within 30 days, 30% of customers will pay after 45
days, and 20% of customers will not change their current paying behaviour.
K Berhad currently orders 15,000 units per month of Product Z, demand for which is
constant. There is only one supplier of Product Z and the cost of Product Z
purchases over the last year was RM540,000. The supplier has offered a 2%
discount for orders of Product Z of 30,000 units or more. Each order costs K Berhad
RM150 to place and the holding cost is 24sen per unit per year. K Berhad has an
overdraft facility charging interest of 6% per year.
5|Page
Required:
A. Calculate the net benefit or cost of the proposed changes in trade receivables
policy and comment on your findings.
B. Calculate whether the bulk purchase discount offered by the supplier is
financially acceptable and comment on the assumptions made by your
calculation.
SOLUTION
(a) Calculation of net cost/benefit
Current receivables
Receivables paying within

30 days

45 days

60 days
Revised receivables
Reduction in receivables
Reduction in financing cost
Cost of discount
Net cost of proposed

changes in receivables
policy
Alternative approach to calculation of net cost/benefit
Current receivables days
Revised receivables days
Decrease in receivables
days
Decrease in receivables
(The slight difference compared to the earlier answer is due to rounding)
6|Page
Decrease in financing cost
Net cost of proposed

changes in receivables
policy
Comment:
(b) Cost of current inventory policy
Cost of materials
Annual ordering cost
Annual holding cost
Total cost of current

inventory policy
Cost of inventory policy after bulk purchase discount
Cost of materials after bulk

purchase discount
Annual demand
K Berhad will need to increase its order size to 30,000 units to gain the bulk
discount
Revised number of orders
Revised ordering cost
Revised holding cost
Revised total cost of

inventory policy
Comment:
7|Page
QUESTION 8
V Berhad sells stationery and office supplies on a wholesale basis and has an
annual revenue of RM4 million. The company employs four people in its sales
ledger and credit control department at an annual salary of RM12,000 each. All
sales are on 40 days’ credit with no discount for early payment. Bad debts represent
3% of revenue and V Berhad pay annual interest of 9% on its overdraft. The most
recent accounts of the company offer the following information:
RM’000 RM’000
Non-current assets
Tangible non-current assets 17,500
Current assets
Inventory of goods for resale 900
Receivables 550
Cash 120
1,570
Total assets 19,070
Equity and liabilities

Ordinary shares 3,500
Reserves 11,640
15,140
Non-current liabilities
12% bonds due 20Y0 2,400
8|Page
Current liabilities
Trade payables 330
Overdraft 1,200
1,530
Total equity and liabilities 19,070
V Berhad is considering offering a discount of 1% to customer paying within 14 days,

which it believes will reduce bad debts to 2.4% of revenue. The company also
expects that offering a discount for early payment will reduce the average credit
period taken by customers to 26 days. The consequent reduction in time spent
chasing customers where payment are overdue will allow one member of the credit
control team to take early retirement. Two-thirds of customers are expected to take
advantage of the discount.
Required:
Using the information provided, determine whether a discount for early payment of 1
per cent will lead to an increase in profitability for V Berhad.
SOLUTION
Receivables currently take an

average of
This is in excess of V Berhad’s stated terms
Cost of discount to company
Receivables payment period
New receivables level
Reduction in receivables
Savings on overdraft costs
Reduction in bad debts
Savings in salary
Net effect on V Berhad’s profitability
9|Page
Savings on overdraft
Decrease bad debts
Salary savings
Less: cost of discount
Net savings
10 | P a g e

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CORPORATE FINANCE (UKFF 3013)

JANUARY 2023 TRIMESTER

Existing level of trade

New level of trade

Interest saved on the

Cost of bad debts saved

Net cost of policy

The costs of the current policy are:

The costs under the factor are:

Alternative calculation- From the slides

Cash Conversion Cycle (CCC)

Receivables paying within

Receivables paying within

Receivables paying within

Reduction in financing cost

Net cost of proposed

Alternative approach to calculation of net cost/benefit

Current receivables days

Revised receivables days

(The slight difference compared to the earlier answer is due to rounding)

Decrease in financing cost

Net cost of proposed

(b) Cost of current inventory policy

Annual ordering cost

Annual holding cost

Total cost of current

Cost of inventory policy after bulk purchase discount

Cost of materials after bulk

Revised number of orders

Revised ordering cost

Revised holding cost

Revised total cost of

Equity and liabilities

V Berhad is considering offering a discount of 1% to customer paying within 14 days,

Receivables currently take an

This is in excess of V Berhad’s stated terms

Cost of discount to company

Receivables payment period

New receivables level

Savings on overdraft costs

Reduction in bad debts

Net effect on V Berhad’s profitability

Decrease bad debts

Less: cost of discount

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