SECTION F

OTHERS - QUESTIONS

QUESTION 100
(a)

Cash is no different from any other assetif it is not being utilized properly it is going to result in
lower profits.

Discuss this statement in particular referring to the motives for holding cash.
(b)

The AB Credit Collection Co. Ltd employs agents who collect hire purchase installments and
other outstanding accounts on a door-to-door basis from Monday to Friday. The agents bank the
cash collected to be remitted to head office once per week at the end of the week. The budget for
next year shows that the total collections will be of the order of Rs 5,200,000 and that the
estimated bank overdraft rate is 9%. The collection manager has suggested that a daily remitting
system should be introduced for collectors.

You are required to comment on the significance of this, stating clearly any assumptions you are required
to make. (20 marks)

QUESTION 101
The Thornton Co., a small manufacturing business, was experiencing a short-term liquidity crisis at the
end of 19-9. Its management estimated that the company would need by the end of February 19-10 an
extra Rs 100,000 of funds. It would be six months' after receipt of the funds before it would be able to
repay. The company is already heavily in debt and its normal banker will not advance any more money.
The company has made losses for the last two years and has unused capital allowances. Consequently it
is not thought it will have any corporation tax to pay for a number of years. The accountant has suggested
three possible short-term solutions to the liquidity problem. They are:
(a)

A Rs 100,000 short-term loan at an annual interest rate of 18%. This can be obtained from a local
finance company, and no finding charge will need to be paid.

(b)

The company could forego the cash discounts it has been obtaining on its purchases of materials.
The company purchases approximately Rs 50,000 of materials each month, and has in the past
been paying for these within a month of purchase and obtaining a 2% cash discount, the
discounts are only offered for payment within 30 days. If Thornton takes longer than 90 days to
pay it could endanger its relationship with suppliers.

(c)

The company could factor its trade debtors. A factor has been found who will advance Thornton
75% of the value of the invoices, less the deduction of all factoring charges, immediately upon
receipt of the invoices. The factor will take responsibility for collecting the debts, and pay over to
the company the balance of the value of the invoices, upon receipt of the cash from customers.
On average Thornton's customers pay at the end of the first month following the month in which
the sales took place. The average level of sales of Thornton is Rs 150,000 per month and this
level is expected to remain steady over the next year.
The factor's interest charge is 15% per annum on the amount of money advanced, calculated on
a day-to-day basis. The factoring fee is a charge of 2% of the turnover of Thornton. Thornton
estimate that as a result of the factor's managing the collecting of debts, it will save on bad debts
and the cost of credit control, an amount of Rs 2,000 per month. Surprisingly, the factor would
enter into an agreement with Thornton to cover just the first six months of 19-10. It would begin
with the factoring of January 19-10 sales. The company can use any surplus funds available to
reduce its overdraft which is costing 1% per month.
Required:
(a) Advise the company as to which of these three possibilities is cheapest. (10 marks)

F- 1

SECTION F

OTHERS - QUESTIONS

(b) Assuming Thornton enters into the factoring arrangement, using the information given in the
question, sow the cash flow position for each of the first nine months of 19-10. (6 marks)
(c) What else besides cost would you advise the company to take into account when deciding
between these three possibilities? (4 marks)
(Total 20 marks)
QUESTION 102
Jack Ltd expects to have available only a limited amount of capital during each of the next five years. It
also expects restrictions on its supplies of skilled labour and raw materials type AFC during this period.
The accountant of Jack Ltd has prepared a linear programme, covering the company's activities for the
next five years. The objective function of the programme involves the maximization of the present value of
ordinary dividends, subject to the following constraints:
(1)
that cash payments each year must not exceed cash receipts. .
(2)
that skilled labour hours required each year must not exceed the quantity available for that year,
(3)
the materials type AFC required each year must not exceed the quantity available for that year,
(4)
that no project may be undertaken more than once (although fractions of projects may be
accepted), and
(5)
that negative quantities of projects may not be undertaken, nor may negative dividends be paid.
The solution to the linear programme reveals the following dual prices:
Year

Cash per Rs

1
2
3
4
5

Rs
2.10
1.65
1.30
1.05
0.90

Skilled labour
Per hour
Rs
0.90
1.30
0.00
1.10
0.00

Raw material
AFC per unit
Rs
9.30
8.40
6.50
4.80
1.60

The present total market value of the ordinary shares of Jack Ltd is Rs 17.5 million. The directors
estimate that the minimum return required by ordinary shareholders from their investment in the company
is 10% per annum.
Since the linear programme was formulated, the directors of Jack Ltd have learnt of a new machine which
could be used on several of the projects included in the optimal plan. Purchase of the machine would
result in cash savings of Rs 30,000 in each of the years 2 to 5. Jack Ltd would also save 15,000 skilled
labour hours in years 2, 3, 4 and 5. On the other hand, use of the machine would require 1,000 extra units
of raw material AFC in each of the years 2 to 5.
You are required to:
(a)

Explain the earning of the dual prices given for cash, skilled labour and raw material AFC.
(5 marks)

(b)

Prepare calculations showing the maximum price Jack Ltd should be willing to pay for the new
machine, if payment has to be made in year 1. (10 marks)

(c)

Discuss the usefulness and limitations of dual prices in situations such as that described in the
question. (10 marks)

Ignore taxation.
(Total 25 marks)

F- 2