Questions
1. A processing company with sales of 25 million baht per month. All are credit sales with 60 days term of sales (net 60). However, the actual collection period is 90 days on average. Cost of goods sold is 65% of sales. Average age of inventory is 150 days. The company’s purchasing on credit is 40% of its cost of goods sold, under 30 days term of credit (net30). The actual deferral period is 45 days on average. The opportunity cost is 12% per annum.
a) The company considers changing its credit trading policy from net60 to 1 of the following policies. The first policy is to increase the credit term to 90 days to boost up sales. If the company adopts this policy, sales will increase to 30 million baht per month, while the average collection period will be 120 days. In addition, bad debt will increase from 1% to 2% of sales. Under the second policy, the credit term of 60 days is maintained, but a cash discount of 3% is given to the customers who make a payment within 10 days to accelerate the payments. It is estimated that 50% of customers will receive a cash discount if the second policy is applied. As a result, the average collection period of the company will be shortened to 45 days on average. No effect of this policy on bad debt of the company. Should the company change its credit policy? If yes, which policy should be applied? Show your calculation and lines of reasons to support your answer. (20 Points)
b) One of the company’s suppliers has offered 1% discount for any purchases with cash payment. The company normally receive credit term of 30 days from this supplier, while the actual payment is made 45 days after purchasing. If a bank has offered a short-term loan to the company, with 8.5% annual rate of interest, would it be better if the company make a cash purchasing from the supplier? Show your calculation and lines of reasons to support your answer. (10 Points)
2. A company’s current capital structure has a market value and effective cost as shown in the table below. With the effective tax rate of 20%, what is the company cost of capital or WACC? Clearly show your calculation. (5 Points)
Source Amount ($ Million) Effective Cost (Before-Tax) (%) Long-Term Debt 50 9%
Common Equity 100 18%
Total 150
3. Briefly explain Hamada equation and how it is used. (10 Points) 4. Does the company’s capital structure always at its optimal level? Why? (15 Points)
