FIN 427: Corporate Finance II Date Given: 09-11-19

Homework 2 Date Due: 14-11-19

1. Mr. Abdul Akkas Mian, the finance manager of ‘Motahar Textile Company,” is contemplating
about the most viable way of mobilising funds that have been necessitated by a recent order
from a buyer. The required funds amount to Tk.500 thousand and the money will be needed
for a period of six months. Mr. Akkas Mian is particularly eager about the venture because
successful completion of this order would mean continued business relationship with this big
buyer. He is therefore looking into the possible sources of funding.

After going through its purchase records, Akkas finds out that purchase contracts with two of
its suppliers can enable the company to manage the required financing. The first of these
suppliers, MS Kuddus Yarn Suppliers offers terms 3/15 net 60 and its sales made to Motahar
textile is approximately Tk.800 thousand per year.

The other supplier MS Mukaddis Dyers, sells approximately Tk.650,000 worth dye to Motahar
on terms 2/20 net 60. However, because of its excess capacity, Mukaddis is agreeable to extend
the credit period by another 30 days.

Before choosing from among the two suppliers, Akkas decides to talk to Abdul Wahab the
chief financial officer of Pirelli Bank to see if the funds could be borrowed at a cheaper rate.
Mr. Wahab tells Akkas that the money could be lent to Motahar Textile up to Tk.750,000 for
six months with renewal for another six months at an annual interest rate of 22 percent and a
compensating balance requirement of 15 percent.

Putting these information on the table, Mr. Akkas starts to analyse them to finalise which of
the three sources would be the most viable based on the cost of borrowing.

Which option should Mr. Akkas choose for managing the short-term funding? Justify your
answer with necessary calculations.

2. The “HulChul hardware Company” expects to have sales of Tk.20 million this year under
current operating policies. Its variable costs as a proportion of sales are 0.80, and its cost of
receivables finanacing is 8 percent. Currently the firm’s credit term is net 25. However its
average collection period (DSO) is 30 days, indicating that some customers are paying late,
and its bad debt losses are 3 percent of sales.

The company’s Managing Director Mr. Tejabhai has asked his credit Manager Mr. Radhesham
to evaluate the following alternative credit policy and propose whether this policy should be
adopted.

Under the proposed policy, the credit period will be lengthened to 40 days, which, it is expected,
will raise sales to Tk.20.50 million. Furthermore, the company’s days sales outstanding will
increase 45 days and bad debt losses on the incremental sales would be 5 percent. Existing
customer bad debt losses would remain a 3 percent.

1
 

Mr. Radhesham decides to use the income statement approach for analysing the proposed
changes in the credit policy.

If you were Radhesham, what decision would you have recommended to Tejabhai? Justify your
reasons with necessary calculations.

3. Green Thumb Garden Centers sells 240,000 bags of lawn fertilizer annually. The optimal
safety stock (which is on hand initially) is 1,200 bags. Each bag costs Green Thumb $4,
inventory carrying costs are 20 percent, and the cost of placing an order with its supplier is
$25.

a. What is the economic ordering quantity (EOQ)?

b. What is the total inventory cost at the EOQ level?
c. What is the maximum possible inventory of fertilizer?
d. What will Green Thumb’s average inventory be?
e. How often must the company order?
f. At what level of inventory should Green Thumb place its next order?