QUESTION FOUR Samfya Plc, a company listed on the Lusaka Stock Exchange, is considering two alternative cash management policies on meeting its liability. The company expects to make a series of cash payments of K2.4 million over the forthcoming year and currently has negligible cash holding. These payments will become due at a steady rate. The first option involves making periodic sales from existing holdings of short-term securities. According to financial analysts, the most likely average percentage rate of return on these securities is 15% over the forthcoming year, although this estimate is highly uncertain. Whenever Samfya sells securities, it incurs a transaction fee of k150, and places the proceeds on short-term deposit at 7% per annum interest until needed. The second option involves taking a secured loan for full K2.4million over one year at an interest rate of 18% based on the initial balance of the loan. The lender also imposes a flat arrangement fee of K10,000, which could be met out of existing cash balances. The sum borrowed would be placed in a notice deposit at 10% and drawn down at no cost as and when required. You may assume that cash balances will be run down at an even rate throughout the year. Ignore tax and the time value of money. Required: i) Discuss the objectives of working capital management in financial management (4marks) ii) Evaluate the two alternatives cash management policies and advise as to the most beneficial one. You may use Baumol model where applicable (10marks) iii) Discuss the relative merits of short-term and long-term debt for financing of working capital. (6marks) QUESTION FOUR Samfya Plc, a company listed on the Lusaka Stock Exchange, is considering two alternative cash management policies on meeting its liability. The company expects to make a series of cash payments of K2.4 million over the forthcoming year and currently has negligible cash holding. These payments will become due at a steady rate. The first option involves making periodic sales from existing holdings of short-term securities. According to financial analysts, the most likely average percentage rate of return on these securities is 15% over the forthcoming year, although this estimate is highly uncertain. Whenever Samfya sells securities, it incurs a transaction fee of k150, and places the proceeds on short-term deposit at 7% per annum interest until needed. The second option involves taking a secured loan for full K2.4million over one year at an interest rate of 18% based on the initial balance of the loan. The lender also imposes a flat arrangement fee of K10,000, which could be met out of existing cash balances. The sum borrowed would be placed in a notice deposit at 10% and drawn down at no cost as and when required. You may assume that cash balances will be run down at an even rate throughout the year. Ignore tax and the time value of money. Required: i) Discuss the objectives of working capital management in financial management (4marks) ii) Evaluate the two alternatives cash management policies and advise as to the most beneficial one. You may use Baumol model where applicable (10marks) iii) Discuss the relative merits of short-term and long-term debt for financing of working capital. (6marks)
