BC150404150 (Shahzad Usmani)
SEMESTER Fall 2017
Corporate Finance (FIN622)
Assignment No. 1
Due Date: 24-January-2018 Marks: 10
Topic: Debtors Management
Learning outcome:
This activity will help students to understand how companies select best strategy for efficient
management of different components of working capital.
Question:
A manufacturing company is planning to reduce its debtor administration cost by revising its debtor
management policy. Management of the company has two different plans to work on this idea.
1. Under first plan, discount policy can be applied by offering discount to existing customers on
early payments. This policy will be selected only if it will reduce debtors cost more than the cost
of discount.
2. Under second plan, the company can seek the services of factor to reduce its debtor
administration cost.
Current sales level of the company is Rs.10,00,000 and existing credit term with customers is two
months.
Following information is pertinent to proposed plans:
Discount policy:
Under this plan, the company can offer 1.5% discount to customers if they make payment within 15
days. This discount offering is only intended to reduce the credit terms of existing customers. According
to management estimates, 70% of customers will avail this opportunity. The company requires 16%
return on investment (ROI).
Employing the Factor:
Currently, the company is bearing Rs. 60,000 as total cost of debtor administration including financing
cost and cost of bad debts. The company expects that factor will reduce average collection period from
two months to 15 days at the cost of 5% of sales as factor’s service fee. Factor will provide 70% on
invoice value of sales and will charge 12% interest rate. For rest of 30%, the company can borrow short
term loan at interest rate of 10% from a bank.
Requirement:
a) You are required to find net saving under each proposed policy. (Provide complete working)
b) Based on your findings in part (a), suggest which policy should be selected by the company and
why?
Solution:
(A)
Description / Amount (Rs)(A) Discount Policy
Sales / 1000000
Discount Offered / 0.015
Discount Validity Days / 15
Number of Customers estimated to avail discount / 0.7
Required ROI / 0.16
Exisisting Collection Time(Days) / 60
New Collection Time(Days) / 45
(i)Existing Debtors without discount policy / 166666.6667
(ii)70% are expected to avail the discount / 28767.12329
(ii)25% are expected to decline the discount / 41666.66667
Reduction in Debtors / 96232.87671
Saving on Reduction in Debtors / 15397.26027
Cost of Discount / 10500
Net Savings Under Savings under Discount Policy / 4897.260274
Description / Amount (Rs)
(B)Employing the Factor Services
Sales / 1000000
TOTAL Existing Cost(Admin+Financing+BD) / 60000
Original ACP (Days) / 60
ACP after employing Factor Services (Days) / 15
Factor Service Fee / 0.05
Factor Financing Charge / 0.12
Factor Financing Days / 15
Factor Financing / 0.7
Factor Financing Cost / 3452.054795
Short Term Financing Cost / 1232.876712
Cost of financing / 50000
Total Cost of Financing / 54684.93151
Net Saving / 5315.068493
(B)It is better to employ the Factor services owing to more net savings and a reduced ACP.