FIN2101 BUSINESS FINANCE II MODULE 4- WORKING CAPITAL MANAGEMENT (Week 2) QUESTION 1 Undercounter Wholesalers Ltd currently sells entirely on a cash basis. Undercounter's management is considering introducing cred it sales with discounts to attract new customers The company is considering two alternative options. The first is offering discount terms of 2.5/30, n/60. It is estimated this would increase sales by $500 000 and 30% of these would take advantage of the discount. The second option is discount terms of 10/30, n/ 60, a policy which would increase sales by $600 000 with 50% of these customers taking the discount The variable cost of sales is 75% of sales. The company's required rate of return on all accounts receivable is 1% per month. Undercounter's exis ting custo mers will not seek the credit terms Using the NPV approach, ad vise Undercounter as to which discount policy it should adopt QUESTION 2 Starlight Industries Ltd has to date been a"cash only"company. Management is concerned however, that sales are slipping and is contemplating a move to offer credit in an effort to boost sales. At the moment sales are $1 500 000 per annum and it is anticipated that sales will increase to $2 250 000 per annum if cred it is offered. The firms accountant has prepared the following schedule for the payment of accounts by all customers(new and existing) I month from the time of sale% 2 months from the time of sale% 3 months from the time of sale% The remaining 5% of sales will result in bad debts which will not be collected The variable cost of sales is 75% of sales and these costs are paid at the same time that sales are made. Starlight,'s cost of capital is 1. 25%per month Using the NPv approach, advise management whether the company should proceed with the proposal to offer cred it termsAugust 2003 FIN2101 BUSINESS FINANCE II MODULE 4 – WORKING CAPITAL MANAGEMENT (Week 2) QUESTION 1 Undercounter Wholesalers Ltd currently sells entirely on a cash basis. Undercounter's management is considering introducing credit sales with discounts to attract new customers. The company is considering two alternative options. The first is offering discount terms of 2.5/30, n/60. It is estimated this would increase sales by $500 000 and 30% of these would take advantage of the discount. The second option is discount terms of 10/30, n/60, a policy which would increase sales by $600 000 with 50% of these customers taking the discount. The variable cost of sales is 75% of sales. The company's required rate of return on all accounts receivable is 1% per month. Undercounter's existing customers will not seek the credit terms. Using the NPV approach, advise Undercounter as to which discount policy it should adopt. QUESTION 2 Starlight Industries Ltd has to date been a "cash only" company. Management is concerned, however, that sales are slipping and is contemplating a move to offer credit in an effort to boost sales. At the moment sales are $1 500 000 per annum and it is anticipated that sales will increase to $2 250 000 per annum if credit is offered. The firm's accountant has prepared the following schedule for the payment of accounts by all customers (new and existing): - 1 month from the time of sale - 35% - 2 months from the time of sale - 25% - 3 months from the time of sale - 35% The remaining 5% of sales will result in bad debts which will not be collected. The variable cost of sales is 75% of sales and these costs are paid at the same time that sales are made. Starlight's cost of capital is 1.25% per month. Using the NPV approach, advise management whether the company should proceed with the proposal to offer credit terms