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The document evaluates the financial acceptability of KG Co's factoring offer to ABC Co by comparing current receivables management costs with those under the factoring arrangement, resulting in a net benefit of TZS 6,422,500. Additionally, it analyzes two policies regarding credit sales, concluding that the proposed policy yields a lower net profit than the current policy, suggesting it should not be adopted. Overall, while the factoring offer is beneficial, the proposed credit policy is not financially favorable.

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10 views3 pages

Ally

The document evaluates the financial acceptability of KG Co's factoring offer to ABC Co by comparing current receivables management costs with those under the factoring arrangement, resulting in a net benefit of TZS 6,422,500. Additionally, it analyzes two policies regarding credit sales, concluding that the proposed policy yields a lower net profit than the current policy, suggesting it should not be adopted. Overall, while the factoring offer is beneficial, the proposed credit policy is not financially favorable.

Uploaded by

hamfreymapunda68
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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b) Solution

(a) To Advice on whether the KG Co’s offer is financially acceptable to ABC Co

To determine whether the factoring offer is financially acceptable, a comparison is made between the
current costs of managing receivables and the proposed costs and savings under the factoring
arrangement.

Data on ABC company

Annual credit sales = TZS 1,337,500,000

Bad debts

=1.2% × 1,337,500,000

= TZS 16,050,000

Average receivables: TZS 222,900,000

Cost of financing receivables at 5%:

= 5% × 222,900,000

= TZS 11,145,000

Administration costs: Not given, but will be reduced by TZS 2,500,000 under factoring

Data on KG Co. offer ( FACTOR )

New receivables period = 36 days

New average receivables

= (36/360) × 1,337,500,000

= TZS 133,750,000

Advance by factor

= 80% × 133,750,000

= TZS 107,000,000

Interest on advance at 8%

= 8% × 107,000,000

= TZS 8,560,000

Remaining 20% financed by ABC Co

= 5% × 26,750,000

= TZS 1,337,500
New total financing cost

= 8,560,000 + 1,337,500

= TZS 9,897,500

Factoring fee = 0.7% × 1,337,500,000 = TZS 9,362,500

Bad debts reduced by 75% = 25% × 16,050,000 = TZS 4,012,500

Then ,

Saving on bad debts = 16,050,000 - 4,012,500 = TZS 12,037,500

Administration savings = TZS 2,500,000

Saving in financing cost = 11,145,000 - 9,897,500 = TZS 1,247,500

then

Net benefit = bad debt saving + administration cost saving + financing cost savings – factoring fee

= 12,037,500 + 2,500,000 + 1,247,500 - 9,362,500

= TZS 6,422,500

( c) Solution

WORKING 1

Total cost other than bad debts and cash discount = 70% of credit sales

Present policy = 70% x 2,880,000 = 2,016,000

Proposed policy = 70% x (2,880,000 + 80,000) = 2,072,000

Working 2

Opportunity cost of investments; opportunity cost = total cost x collection period/360 x rate of
return/100

30 10 %
Present policy = 2,016,000 x x (10% - ( ) )= 8,400
360 2

Proposed policy = 2,072,000 x


20
360 (
x 10 %−
10 %
2 )
= 5,756

Working 3

Cash discount = total credit sales x % of customers who take up discount x rate/100

= 2,960 x 60% x 2%

= 35,520
ITEMS Current policy Proposed policy
Credit sale 2,880,000 2,960,000
Total cost other than bad debts and cash discount 2,016,000 2,072,000
Bad debts 57,600 59,200
Cash discount 35,520
Profit before tax 806,400 793,280
Less tax (241,920) (237,984)
Profit after tax 564,480 555,296
Less opportunity cost of investment (8,400) (5,756)
Net profit 556,080 549,540

Since, net profit of proposed policy is lower than current policy. Then The proposed policy should not
be adopted.

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