Corporate Finance CORPORATE

CORPORATE FINANCE (UKFF 3013)

JUNE 2022 TRIMESTER

TUTORIAL 4 (WEEK STARTING 04 JULY 2022)

WORKING CAPITAL MANAGEMENT (CHAPTER 3)

1 | P a g e

QUESTION 1 – Factoring

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?

SUGGESTED ANSWER

RM

Current level of trade

receivables

RM4.5m x (50 days/365 days)

616,438

Under the factor, trade

receivables will fall to

RM4.5m x (30 days/365 days)

369,863

Decrease in receivable

616,438 – 369,863

246,575

Interest saving from using

overdraft

246,575 x 0.1 (10%)

24,657.5

The costs of the current policy are:

RM

Cost of financing current

receivables

616,438 x 0.1 (10%)

61,644

Cost of bad debts

RM4.5m x 0.4% (0.004)

18,000

Cost of current policy

61,664 + 18,000

79,644

CORPORATE FINANCE (UKFF 3013)

JUNE 2022 TRIMESTER

TUTORIAL 4 (WEEK STARTING 04 JULY 2022)

WORKING CAPITAL MANAGEMENT (CHAPTER 3)

2 | P a g e

The costs under the factor are:

RM

(369,863 x 0.8 x 11%) + (369,863 x 0.2 x 10%)

= (32,548 + 7,397)

39,945

Factor’s annual fee

Rm4.5m x 0.01

45,000

Saved administrative cost

(35,000)

Net cost under factor

49,945

Comment

Cost-benefit analysis shows the factor’s services

are cheaper than the current practice by

RM29,699 (79,644 – 49,945) per year. On

financial grounds, the services of the factor

should be accepted as it will maximize

shareholders’ wealth.

Alternative calculation- From the slides

RM

Interest saving

+24,658

Decrease in bad debts

+18,000

Admin cost saving

+35,000

Factor Fee

4,500,000 x 0.01

(45,000)

Interest on advance

369,863 x (11 – 10) x 0.8

(2,959)

Saving using factor

29,699

QUESTION 2 – Overtrading

At a recent management meeting, the Finance Director of K Berhad, a supplier of

quality decorative wooden doors, highlighted that the company might be suffering

from liquidity problems as a result of overtrading.

Given below are extracts of the financial information of K Berhad for 20×1 and

forecast financial information for 20×2.

20x2

20x1

RM000

Sales (all on credit)

9,500

6,700

Cost of sales

(8,550)

(5,945)

Operating profit

950

755

CORPORATE FINANCE (UKFF 3013)

JUNE 2022 TRIMESTER

TUTORIAL 4 (WEEK STARTING 04 JULY 2022)

WORKING CAPITAL MANAGEMENT (CHAPTER 3)

3 | P a g e

Finance costs (interest payments)

(100)

(70)

Profit before taxation

850

685

Non-current assets

3,400

3,188

Current assets

Inventory

1,258

600

Trade receivables

1,050

500

Cash

–

50

2,308

1,150

5,708

4,338

Capital and reserves

Share capital

1,500

Reserves

1,608

1,332

3,108

2,832

Current liabilities

Trade payables

1,188

500

Overdraft

806

400

Non-current liability

606

8% Bonds

606

5,708

4,338

The Finance Director had reported to the members of the board that the bank was

insisting the company reduce its overdraft urgently. It was suggested that the

company could consider factor finance as an alternative source of funds for working

capital investment.

Following the meeting, the Finance Director found a factor who would take over

administration of the company’s receivables on a non-recourse basis for an annual

fee of 0.5% of turnover. The factor would advance 80% of the book value of

receivables at an annual interest rate of 1% above the company’s current overdraft

rate. The factor expects to reduce the average receivables period to 10 days. With

the factor services, K Bhd could save RM24,000 per year in administration costs.

Currently, the company pays 5% overdraft interest.

Required:

CORPORATE FINANCE (UKFF 3013)

JUNE 2022 TRIMESTER

TUTORIAL 4 (WEEK STARTING 04 JULY 2022)

WORKING CAPITAL MANAGEMENT (CHAPTER 3)

Write a report to the board of K Berhad to advise them if the company is

overtrading.