- 1 Marks
BMF – MAY 2015 – L1 – SA – Q15 – Basics of Business Finance and Financial Markets
Identifying the most commonly used source of short-term finance for businesses.
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Question Tag: Trade Credit
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+ past questions and counting.
- 20 Marks
FM – DEC 2023 – L2 – Q5 – Cost of capital | Foreign exchange risk and currency risk management
Calculation of the effective cost of various financing options and explanation of internal strategies to manage foreign currency risk.
Question
a) Markwei Pharmaceuticals Ltd plans to import active ingredients to produce vitamin syrup. The company’s managers are considering three financing options for the cedi equivalent of an invoice value of GH¢2.5 million. The options are detailed below:
Option 1: Use supplier’s credit. The credit term is 1.5/10 net 45.
Option 2: Issue a commercial paper to raise the money from the Ghanaian money market. The commercial paper will pay interest at the rate of 18% per annum. Issue costs totaling GH¢15,000 will be incurred.
Option 3: Obtain a 3-month bank loan. The interest rate on the loan is 22% per annum. Loan arrangement and processing fees are expected to be GH¢5,000.
Required:
i) Compute the effective annual cost of each financing option and recommend the most cost-effective option. (10 marks)
ii) Explain TWO (2) advantages of financing the invoice through the issue of a commercial paper instead of a bank loan. (5 marks)
b) Abongo Shoes Ltd (Abongo) imports leather from Italy. Abongo’s demand for euros to settle its import bills exposes its cash flow to foreign exchange risk. Abongo’s Management is looking for internal strategies they can deploy to hedge the company’s currency risk exposure as external hedging strategies might be too expensive for the company.
Required:
Explain TWO (2) internal strategies for managing foreign currency risk exposures that Abongo’s Management can use. (5 marks)
Find Related Questions by Tags, levels, etc.
- Tags: Bank Loan, Commercial Paper, Cost of Finance, Currency risk, Hedging Strategies, Trade Credit
- Level: Level 2
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- 20 Marks
FM – MAY 2016 – L2 – Q2 – Working Capital Management
Assessing XYZ Ltd's overtrading status and evaluating proposals to improve cash flow management.
Question
XYZ Ltd is a leading producer of mineral water in Ghana. The company sells all of its output to wholesalers on credit terms net 40. The company’s collection policy is somewhat relaxed, and so the receivables turnover days are currently 53 days. This fairly liberal credit policy has resulted in significant increases in sales revenue in recent years. However, the company has been facing cash flow problems as a significant number of customers take longer than the credit period to settle their accounts. The company typically falls on overdraft facilities from its bankers when it fails to generate adequate cash flows from operations to meet working capital requirements. The average cost of the overdraft facilities is 15% per annum.
Last week, the management team met and discussed the company’s cash flow and liquidity problems with a view to finding solutions to the problems. In that meeting, two proposals were offered to help solve the problems:
Proposal 1: Introduce an early settlement discount of 1.5% on accounts that are settled within 10 days of invoice while the current credit period is maintained. It is estimated that 60% of accounts will be paid within the discount period.
Proposal 2: Switch from financing working capital requirements using the bank overdraft facilities at 15% interest to financing working capital requirements using suppliers’ trade credit. Suppliers are willing to supply on credit terms 1/10, net 40.
Set out below are the company’s income statement and statement of financial position for the past three years.
Income statement for the year ended 31st December
| 2012 | 2013 | 2014 | |
|---|---|---|---|
| Revenue | 40,000 | 60,000 | 122,000 |
| Cost of sales | (15,000) | (31,000) | (90,000) |
| Gross profit | 25,000 | 29,000 | 32,000 |
| Selling and administrative expenses | (11,000) | (13,000) | (17,500) |
| Operating profit | 14,000 | 16,000 | 14,500 |
Statement of financial position as at 31st December
| 2012 | 2013 | 2014 | |
|---|---|---|---|
| Noncurrent assets: | |||
| Property, plant and equipment | 13,400 | 19,000 | 22,500 |
| Current assets: | |||
| Inventory | 8,000 | 15,500 | 25,500 |
| Trade receivables | 6,900 | 11,210 | 24,210 |
| Cash | 1,110 | – | – |
| Total current assets | 16,010 | 26,710 | 49,710 |
| Total assets | 29,410 | 45,710 | 72,210 |
| Equity: | |||
| Stated capital | 100 | 100 | 100 |
| Income surplus | 18,510 | 28,110 | 36,810 |
| Shareholders’ equity | 18,610 | 28,210 | 36,910 |
| Non-current liabilities: | |||
| Medium-term loan | 3,000 | 2,500 | 2,000 |
| Current liabilities: | |||
| Trade payables | 2,200 | 3,500 | 8,600 |
| Dividend payable | 5,600 | 6,400 | 7,500 |
| Bank overdraft | – | 5,100 | 17,200 |
| Total current liabilities | 7,800 | 15,000 | 33,300 |
| Total liabilities | 10,800 | 17,500 | 35,300 |
| Total equity and liabilities | 29,410 | 45,710 | 72,210 |
Required:
a) Considering the background information and financial data provided above, would you conclude that XYZ Ltd is experiencing overtrading? Explain with relevant computations. (9 marks)
b) Appraise the proposal for early settlement discount (i.e. Proposal 1) and advise on whether it should be accepted for implementation or not. Your appraisal should focus on how the discount policy will influence the company’s profitability. Show all relevant computations. (5 marks)
c) Appraise the proposal to switch from financing working capital needs using bank overdraft to using suppliers’ trade credit, and advise management accordingly. Show all relevant computations. (3 marks)
d) Assuming XYZ Ltd cannot raise additional funds from external sources such as borrowing and new share offers, suggest to management three steps they can take to ease the cash shortages the company is facing. (3 marks)
Find Related Questions by Tags, levels, etc.
- Tags: Early Settlement, Overtrading, Trade Credit
- Level: Level 2
- Topic: Working Capital Management
- Series: MAY 2016
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- 20 Marks
FM – MAR 2024 – L2 – Q5 – Working Capital Management
Evaluates different financing options for working capital requirements and compares forward and futures currency contracts.
Question
a) Edziban Foods Ltd has just signed a contract to sell food items worth GH¢120,000 per month to the School Feeding Secretariat on credit. With the average collection period expected to be 45 days, the company will increase its working capital requirement by GH¢177,534. The company’s managers are considering three options for financing the additional working capital requirement:
- Option 1 – Trade credit: The company buys about GH¢72,000 of food items per month on terms of “2.5/20, net 60.” Going forward, the company may choose to forgo the discount.
- Option 2 – Factoring: The company enters a non-recourse factoring contract, under which the factor takes up the receivables to be created from the credit sales under the contract (i.e., GH¢120,000 per month) for a fee of 2% of the credit sales. The average collection period for the credit sales will remain at 45 days. The factor will advance up to 80% of the face value of the average receivables at an annual interest rate of 16%. It has been estimated that the factor’s services will save the company GH¢1,500 per month in debt collection costs.
- Option 3 – Bank loan: The company takes a loan of GH¢197,260 at 15% from its bankers. A 10% compensating balance will be required.
Required:
i) Recommend the best financing option to the managers of the company based on annualized percentage cost.
(11 marks)
ii) Distinguish between “without recourse” factoring agreement and “with recourse” factoring agreement.
(4 marks)
b) Explain THREE (3) differences between a forward currency contract and a futures currency contract.
(5 marks)
Find Related Questions by Tags, levels, etc.
- Tags: Bank Loan, Factoring, Forward Contracts, Futures Contracts, Trade Credit, Working Capital
- Level: Level 2
- Topic: Working Capital Management
- Series: MAR 2024
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- 1 Marks
BMF – MAY 2015 – L1 – SA – Q15 – Basics of Business Finance and Financial Markets
Identifying the most commonly used source of short-term finance for businesses.
Find Related Questions by Tags, levels, etc.
Report an error
- 20 Marks
FM – DEC 2023 – L2 – Q5 – Cost of capital | Foreign exchange risk and currency risk management
Calculation of the effective cost of various financing options and explanation of internal strategies to manage foreign currency risk.
Question
a) Markwei Pharmaceuticals Ltd plans to import active ingredients to produce vitamin syrup. The company’s managers are considering three financing options for the cedi equivalent of an invoice value of GH¢2.5 million. The options are detailed below:
Option 1: Use supplier’s credit. The credit term is 1.5/10 net 45.
Option 2: Issue a commercial paper to raise the money from the Ghanaian money market. The commercial paper will pay interest at the rate of 18% per annum. Issue costs totaling GH¢15,000 will be incurred.
Option 3: Obtain a 3-month bank loan. The interest rate on the loan is 22% per annum. Loan arrangement and processing fees are expected to be GH¢5,000.
Required:
i) Compute the effective annual cost of each financing option and recommend the most cost-effective option. (10 marks)
ii) Explain TWO (2) advantages of financing the invoice through the issue of a commercial paper instead of a bank loan. (5 marks)
b) Abongo Shoes Ltd (Abongo) imports leather from Italy. Abongo’s demand for euros to settle its import bills exposes its cash flow to foreign exchange risk. Abongo’s Management is looking for internal strategies they can deploy to hedge the company’s currency risk exposure as external hedging strategies might be too expensive for the company.
Required:
Explain TWO (2) internal strategies for managing foreign currency risk exposures that Abongo’s Management can use. (5 marks)
Find Related Questions by Tags, levels, etc.
- Tags: Bank Loan, Commercial Paper, Cost of Finance, Currency risk, Hedging Strategies, Trade Credit
- Level: Level 2
Report an error
- 20 Marks
FM – MAY 2016 – L2 – Q2 – Working Capital Management
Assessing XYZ Ltd's overtrading status and evaluating proposals to improve cash flow management.
Question
XYZ Ltd is a leading producer of mineral water in Ghana. The company sells all of its output to wholesalers on credit terms net 40. The company’s collection policy is somewhat relaxed, and so the receivables turnover days are currently 53 days. This fairly liberal credit policy has resulted in significant increases in sales revenue in recent years. However, the company has been facing cash flow problems as a significant number of customers take longer than the credit period to settle their accounts. The company typically falls on overdraft facilities from its bankers when it fails to generate adequate cash flows from operations to meet working capital requirements. The average cost of the overdraft facilities is 15% per annum.
Last week, the management team met and discussed the company’s cash flow and liquidity problems with a view to finding solutions to the problems. In that meeting, two proposals were offered to help solve the problems:
Proposal 1: Introduce an early settlement discount of 1.5% on accounts that are settled within 10 days of invoice while the current credit period is maintained. It is estimated that 60% of accounts will be paid within the discount period.
Proposal 2: Switch from financing working capital requirements using the bank overdraft facilities at 15% interest to financing working capital requirements using suppliers’ trade credit. Suppliers are willing to supply on credit terms 1/10, net 40.
Set out below are the company’s income statement and statement of financial position for the past three years.
Income statement for the year ended 31st December
| 2012 | 2013 | 2014 | |
|---|---|---|---|
| Revenue | 40,000 | 60,000 | 122,000 |
| Cost of sales | (15,000) | (31,000) | (90,000) |
| Gross profit | 25,000 | 29,000 | 32,000 |
| Selling and administrative expenses | (11,000) | (13,000) | (17,500) |
| Operating profit | 14,000 | 16,000 | 14,500 |
Statement of financial position as at 31st December
| 2012 | 2013 | 2014 | |
|---|---|---|---|
| Noncurrent assets: | |||
| Property, plant and equipment | 13,400 | 19,000 | 22,500 |
| Current assets: | |||
| Inventory | 8,000 | 15,500 | 25,500 |
| Trade receivables | 6,900 | 11,210 | 24,210 |
| Cash | 1,110 | – | – |
| Total current assets | 16,010 | 26,710 | 49,710 |
| Total assets | 29,410 | 45,710 | 72,210 |
| Equity: | |||
| Stated capital | 100 | 100 | 100 |
| Income surplus | 18,510 | 28,110 | 36,810 |
| Shareholders’ equity | 18,610 | 28,210 | 36,910 |
| Non-current liabilities: | |||
| Medium-term loan | 3,000 | 2,500 | 2,000 |
| Current liabilities: | |||
| Trade payables | 2,200 | 3,500 | 8,600 |
| Dividend payable | 5,600 | 6,400 | 7,500 |
| Bank overdraft | – | 5,100 | 17,200 |
| Total current liabilities | 7,800 | 15,000 | 33,300 |
| Total liabilities | 10,800 | 17,500 | 35,300 |
| Total equity and liabilities | 29,410 | 45,710 | 72,210 |
Required:
a) Considering the background information and financial data provided above, would you conclude that XYZ Ltd is experiencing overtrading? Explain with relevant computations. (9 marks)
b) Appraise the proposal for early settlement discount (i.e. Proposal 1) and advise on whether it should be accepted for implementation or not. Your appraisal should focus on how the discount policy will influence the company’s profitability. Show all relevant computations. (5 marks)
c) Appraise the proposal to switch from financing working capital needs using bank overdraft to using suppliers’ trade credit, and advise management accordingly. Show all relevant computations. (3 marks)
d) Assuming XYZ Ltd cannot raise additional funds from external sources such as borrowing and new share offers, suggest to management three steps they can take to ease the cash shortages the company is facing. (3 marks)
Find Related Questions by Tags, levels, etc.
- Tags: Early Settlement, Overtrading, Trade Credit
- Level: Level 2
- Topic: Working Capital Management
- Series: MAY 2016
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- 20 Marks
FM – MAR 2024 – L2 – Q5 – Working Capital Management
Evaluates different financing options for working capital requirements and compares forward and futures currency contracts.
Question
a) Edziban Foods Ltd has just signed a contract to sell food items worth GH¢120,000 per month to the School Feeding Secretariat on credit. With the average collection period expected to be 45 days, the company will increase its working capital requirement by GH¢177,534. The company’s managers are considering three options for financing the additional working capital requirement:
- Option 1 – Trade credit: The company buys about GH¢72,000 of food items per month on terms of “2.5/20, net 60.” Going forward, the company may choose to forgo the discount.
- Option 2 – Factoring: The company enters a non-recourse factoring contract, under which the factor takes up the receivables to be created from the credit sales under the contract (i.e., GH¢120,000 per month) for a fee of 2% of the credit sales. The average collection period for the credit sales will remain at 45 days. The factor will advance up to 80% of the face value of the average receivables at an annual interest rate of 16%. It has been estimated that the factor’s services will save the company GH¢1,500 per month in debt collection costs.
- Option 3 – Bank loan: The company takes a loan of GH¢197,260 at 15% from its bankers. A 10% compensating balance will be required.
Required:
i) Recommend the best financing option to the managers of the company based on annualized percentage cost.
(11 marks)
ii) Distinguish between “without recourse” factoring agreement and “with recourse” factoring agreement.
(4 marks)
b) Explain THREE (3) differences between a forward currency contract and a futures currency contract.
(5 marks)
Find Related Questions by Tags, levels, etc.
- Tags: Bank Loan, Factoring, Forward Contracts, Futures Contracts, Trade Credit, Working Capital
- Level: Level 2
- Topic: Working Capital Management
- Series: MAR 2024
Report an error