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.

Required: 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 re

Answer 1

AGGRESSIVE FUNDING STRATEGY:

Use of Short term finance for both permanent and temporary working capital.

Permanent Requirement =350000

Average seasonal requirement=525100

Total Fund needed=350000+525100=875100

Annual interest cost =875100*12.5%=109388

CONSERVATIVE FUNDING STRATEGY:

Use of Long Term Finance

The surplus fund can be invested.

Annual interest cost for Long Term Finance =1600000*8%=128000

Interest income from investing surplus fund=724900*7%=50743

Net Annual Interest Cost =128000-50743=77257

7.2. Recommended strategy:

CONSERVATIVE FUNDING STRATEGY

Resons:

1. Lower Cost

2. Lower Risk

Long term fund will not have fluctuation of interest