QUESTION $1(51$ marks$)$

Creamed Ltd $($Creamed$)$ is a retailer selling various household appliances.

In the recent financial periods, Creamed generated disappointing net profits. After analysing the financial figures, areas of concern were identified. One of the areas of concern was that $18\%$ of the credit sales for which the early settlement discount was not taken resulted in bad debt.

In order to rectify this, management is considering changing Creamed $$s credit terms to $7/12$ net $35$ from the current $2/15$ net $45.$ From market research, it appears that $40\%$ of the credit sales will then not be motivated to make use of early settlement opposed to the current situation where $47\%$ of the credit sales make use of the early settlement discount.

Although the number of customers opting to pay on credit rather than cash is estimated to stay fixed at $80\%,$ the annual sales are estimated to change from R$1600000$ to R$2500000.$ The opportunity cost is however expected to stay constant at $11\mathrm{.}9\%.$

The bad debt is estimated to only change slightly to $14\%$ of the credit sales where early settlement is not executed. The gross profit margin of Creamed will remain unchanged at $31\%.$

Given the higher sales expected, Creamed will have to purchase and carry more inventory. Currently on average, $7442$ units are sold annually, each with an ordering cost of R$1,55.$ The cost of carrying $7442$ units amounts to R$89304$ per annum. The current sales are expected to increase to $11628$ units annually. The ordering and carrying costs are expected to stay unchanged per unit.

Assume standard years consisting of $365$ days and that Creamed utilises the economic order quantity to determine the entity$$s average inventory level.

Creamed employs a moderate working capital finance policy.

REQUIRED:

$1\mathrm{.}1.$ Calculate the effect on the annual net profit should Creamed Ltd change the entity$$s credit policy. Advise, based on this result, whether Creamed Ltd should proceed with the change in credit policy.

Round to two decimals where required.

$(42$ marks$)$

$1\mathrm{.}2.$ Two specific financial risks arise from this part of Creamed Ltd $$s operations.

Name and explain these two $(2)$ financial risks in Creamed Ltd $$s context.

Provide two $(2)$ suggestions per financial risk to Creamed Ltd to manage the risk.

$(9$ marks$)$