Question

Question 7 (26)

Rims & Tyres is a company that specialises in the supply and fit of tyres and rims for all types of vehicles.

The company experiences a surge in demand for its product during certain times of the year. An analysis of its working capital requirements over the last 5 years indicates that it has a permanent funding requirement of R350 000 in operating assets and seasonal requirements that vary between R0 and R1 250 000, with an average seasonal requirement of R525 100.

The total peak need for cash is R1 600 000 and the average cash surplus is R724 900.

The company can borrow short-term funds at 12.5% and long-term funds at 8.0%. It can earn 7.0% on surplus fund investments.

Company management must decide on the most suitable funding strategy given the above circumstances. As a member of the management team, you have been assigned the task of using the information available to conduct a funding strategy analysis.

Show all calculations and round off all final answers to the closest rand.

7.1. Compare the annual costs for both an aggressive funding strategy and a conservative funding strategy. (20)

7.2. Which funding strategy would you recommend to the management of Rims & Tyres? Substantiate your recommendation. (6)

I have just contacted my lecturer and he's adamant that the question is complete;

		10:42 (35 minutes ago)
Are we not supposed to be given the average of seasonal funds on question 7?

0:50 (26 minutes ago)
to me

All the information you need are in the question

Answer 1

All amounts are in "R"

Aggressive funding strategy - It is a mode of working capital funding where short term funds are used not only for short term investment or working capital use but also for some part of permanent working capital.

Conservative funding strategy - It is type of working capital finance where the long term funds are used for short term requirements of wokring capital.

Aggressive funding strategy Costs

= Average seasonal requirement x Short term borrowing rate

= 525,100 x 12.5%

= 65,637.5

Conservative funding costs

= (Total seasonal requirement x long term borrowing rate) - (Average surplus x Short term investment rate)

= (1,250,000 x 8%) - (724,900 x 7%)

= 49,257

So, the costs under conservative approach is lower and hence it is preferable

Both the methods have their own advantages and disadvantages

Aggressive approach have advantages like no idle funds in business, no need to check for better short term investment to manage idle cash. It has disadvantages like there may be stoppage in work flow, if we don't find the short term borrowings in time as it leads to working capital shortage.

Conservative approach also have its own advantages like availability of funds everytime means no stopping in the flow of work. It's disadvantage is to find the short term investments to put your idle money and make revenue which helps in reduction of costs.

In light of above discussion and the cost under each approach, it is better to follow conservative approach for this entity