Question 1 (Marks: 30)

Diamond Ltd is seeking to improve its accounts collection period and reduce its bad debts.

The financial manager has proposed increasing the early settlement discount in order to encourage

customers to pay even earlier.

Diamond Ltd.s current collection period is 40 days on annual sales of 300 000 units. The selling

price and variable cost are R60 per unit and R40 per unit respectively.

Bad debts as a percentage of sales are 4%.

The company is proposing to increase the current cash discount from 2% for early settlement within

15 days of the credit sales to 6%.

The financial manager estimates that the percentage of customers who will take the discount will

increase from 10% to 35%.

The financial manager also expects:

1. Unit sales to increase by 20% per annum.
2. A reduction in the accounts receivable collection period by 25%; and
3. A reduction in the bad debt percentage to 1,5% of sales.

Diamond Ltd.s cost of investment in accounts receivable is 14% per annum. Assume a 360-day year.

REQUIRED:

Q.1.1 Determine whether Diamond Ltd should increase the early settlement discount. (25)

Q.1.2 The directors of Diamond Ltd have asked for your assistance in analysing how

effectively they are managing their working capital. Explain to the board the benefit

of effective working capital management and the drawbacks of being either overly

conservative or too aggressive. (5)