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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 20x1 and
forecast financial information for 20x2.
20x2
20x2
20x1
20x1
RM000
RM000
RM000
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
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.
SUGGESTED ANSWER
Answer To: The Board of K Berhad
From: Financial Manager Date: xx/xx/xxxx
Subject: Is the company moving into overtrading
Growth in sales
9,500 .00 – 6,700.00 x 100
6,700.00
41.79% or 42%
Growth in current
assets
2,308.00 – 1,150.00 x 100
1,150.00
100.70% or 101%
Increase in Overdraft
806.00 – 400.00 x 100
400.00
101.5% or 102%
Increase in Trade
payables
1,188.00 – 500.00 x 100
500.00
137.6 % or 138%
Asset on current assets
3,400.00 – 3,188.00 x 100
