Question $1[25$ marks$]$

Voest Ltd manufactures a wide range of products. It manufactures products developed both

in$-$house and designed by market leaders. In $2018,$ Voest entered an agreement with

Steglich Ltd$.$ Steglich Ltd is based in Munich Germany. Steglich is a global leader in

manufacturing specialized high$-$carbon content mining drills. Voest Ltd obtained the right to

manufacture and sell the high carbon content mining drills. The specialised high$-$carbon

content mining drills will be distributed in southern Africa. Voest Ltd pays a fixed royalty in

euros for each unit of specialised high$-$carbon content mining drills manufactured and sold.

The royalties are paid quarterly in arrears. The specialised high$-$carbon content mining drills

have proved to be very successful in South Africa. This is because of the relatively complex

geological structure of the southern African region. The total revenue from the high$-$carbon

content specialised drills represents $30\%$ of the total annual revenue of Voest Ltd$.$ Voest Ltd

has been focusing primarily on South African customers. However, Voest Ltd has also

supported the subsidiaries of South African customers that are in the rest of Africa and the

Middle East. The revenues from these foreign subsidiaries constitute about $10\%$ of the total

annual revenue. These subsidiaries are also invoiced in euros.

The mining industry in South Africa has been under a lot of pressure during the past few

years because of the slow global economic growth. The slow rate of growth is caused by

geopolitical tensions between global economic superpowers. It is for this reason that Voest

has struggled to grow its revenue over the past three years. A special type of steel is used

in the manufacture of specialised high$-$carbon content mining drilling equipment. The steel

prices have also been very volatile over the past few years. This has also added to the

pressure on the company$$s profit margins.

Working capital management has become very important to Voest Ltd$.$ That is$,$ staying afloat

has become a priority. This is due to several reasons. Firstly, a significant number of

customers have been placing orders at the last moment. This caused Voest to hold larger

volumes of inventory to meet the unexpected demand from these customers. It is important

to note that one hundred percent $(100\%)$ of Voest Ltd$.$s sales are on credit. Voest Ltd allows

its customers $60$ days to pay from the invoicing date. Many customers have been delaying

payments due to cashflow problems. Because of this, Voest Ltd$.$s bank overdraft has been

increasing over the years, such that it has become a permanent source of finance. The

interest on overdraft is $10\%$ per annum, compounded monthly. Voest Ltd has had no other

debt since $2021.$ Bankers are currently not very willing to grant Voest Ltd long$-$term finance.

This is due to concerns about the company$$s cashflow generation ability and the negative

outlook in the mining industry in general.

To improve the cashflows; the following two options have been proposed by the

management:

$1)$ The company proposes to offer a $10\%$ settlement discount to all customers who pay

within $30$ days. This is expected to increase revenue by $5\%.$ The company expects

$20\%$ of all customers $($by revenue value$)$ to make use of the settlement discount. The

introduction of the settlement discount is expected to reduce bad debts by $5\%.$

$2)$ This option involves Voest Ltd discontinuing the manufacture of specialized highcarbon content mining drilling equipment. Voest Ltd would purchase the equipment

directly from Steglich Ltd$.$ Voest Ltd would be granted payment terms of $30$ days from

the invoice date. The option of purchasing would expose Voest Ltd to foreign currency

movements. However, the finance manager has advised the board that any exposure

to currency movements would be hedged using suitable financial instruments.

Extracts from the income statement for the year ended $31$ December $2023$

$20232022$

R R

Sales $248230000241000000$

Cost of sales $(157580000)(144400000)$

Gross profit $9065000096600000$

Bad debts $(5100000)(4500000)$

Depreciation $(19800000)(20100000)$

Research and development $(10200000)(11100000)$

Other operating costs $(28750000)(26700000)$

Operating profit $2680000034200000$

Finance charges $(12750000)(10800000)$

Profit before tax $1405000023400000$

Extracts from the balance sheet as at $31$ December $2023$

$202320$

Required:

a$)$ Evaluate the working capital position and the profitability of Voest

Ltd for the $2022$ and $2023$ financial years. $(15$ Marks$)$

b$)$ Evaluate the impact of introducing the settlement discount on the

profitability and cashflows of Voest Ltd$.(10$ Marks$)$