ACCA FM Syllabus C. Working Capital Management - Early Settlement Discounts (Creditors) - Past Papers ^{1 / 1}

Nesud Co has credit sales of $45 million per year and on average settles accounts with trade payables after 60 days.

One of its suppliers has offered the company an early settlement discount of 0·5% for payment within 30 days.

Administration costs will be increased by $500 per year if the early settlement discount is taken. Nesud Co buys components worth $1·5 million per year from this supplier.

From a different supplier, Nesud Co purchases $2·4 million per year of Component K at a price of $5 per component.

Consumption of Component K can be assumed to be at a constant rate throughout the year. The company orders components at the start of each month in order to meet demand and the cost of placing each order is $248·44. The holding cost for Component K is $1·06 per unit per year.

The finance director of Nesud Co is concerned that approximately 1% of credit sales turn into irrecoverable debts. In addition, she has been advised that customers of the company take an average of 65 days to settle their accounts, even though Nesud Co requires settlement within 40 days.

Nesud Co finances working capital from an overdraft costing 4% per year. Assume there are 360 days in a year.

Required:
(a) Evaluate whether Nesud Co should accept the early settlement discount offered by its supplier. (4 marks)

ZXC Co currently has income of $30 million per year, of which 80% is from credit sales, and a net profit margin of 10%. Due to fierce competition, ZXC Co has lost market share and is looking for ways to win back former customers and to keep the loyalty of existing customers. The sales director has pointed out that a major competitor of ZXC Co currently offers an early settlement discount of 0·5% for settlement within 30 days, while ZXC Co itself does not offer an early settlement discount. He suggests that if ZXC Co could match this early settlement discount, annual income from credit sales would increase by 20%.

Credit customers of ZXC Co take an average of 51 days to settle invoices. Approximately 0·5% of the company’s credit sales have historically become bad debts each year and written off as irrecoverable. The finance director has been advised that offering an early settlement discount of 0·5% for payment within 30 days would increase administration costs by $35,000 per year, while 75% of credit customers would be likely to take the discount. The credit controller believes that bad debts would fall to 0·375% of credit sales if the early settlement discount were introduced.

ZXC Co has an average short-term cost of finance of 4% per year. Assume that there are 360 days in each year.

Required:
(a) Evaluate whether ZXC Co should introduce the early settlement discount. (6 marks)

Plot Co sells both Product P and Product Q, with sales of both products occurring evenly throughout the year.

Product P

The annual demand for Product P is 300,000 units and an order for new inventory is placed each month. Each order costs $267 to place. The cost of holding Product P in inventory is 10 cents per unit per year. Buffer inventory equal to 40% of one month’s sales is maintained.

Product Q

The annual demand for Product Q is 456,000 units per year and Plot Co buys in this product at $1 per unit on 60 days credit. The supplier has offered an early settlement discount of 1% for settlement of invoices within 30 days.

Other information

Plot Co finances working capital with short-term finance costing 5% per year. Assume that there are 365 days in each year.

Required:

Calculate the net value in dollars to Plot Co of accepting the early settlement discount for Product Q. (5 marks)