Voest ltd is a manufacturer and distributor of mine drilling equipment. All of its customers are in the extraction industry. The technology in the extraction industry has been changing rapidly in recent years. As a result of this rapid change, Voest ltd has been investing significantly in research and development in order to keep pace with the changes in the industry. The company is focused on becoming the market leader in its existing product offering. The company has patented many of its existing products. This was obviously done to protect the companys intellectual property.

For Voest working capital management has become very crucial in order to stay afloat. This was caused by a number of factors. Initially, a significant number of customers have been placing orders at the last moment. This caused Voest to hold larger volumes of inventory in order to meet the unexpected demand from these customers. It is important to note that all Voest Ltds sales are on credit. Voest ltd allows its customers 60 days to pay from the invoicing date. A lot of customers have been delaying payments due to cash flow problems. As a result of this Voest Ltds 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 2019. Bankers are currently not very willing to grant Voest ltd long-term finance. This is due to concerns about the companys cash flow generation ability and the negative outlook in the mining industry in general.

In order to improve the cash flows; the following two options have been proposed by the management:

The company proposes to offer a 10% settlement discount to all customers that 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%.

This option involves Voest ltd discontinuing the manufacture of specialized mine 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 forward or option contracts.

Extracts from the income statement for the year ended 31 December 2021

2021 2020

R R

Sales 248 230 000 241 000 000

Cost of sales (157 580 000) (144 400 000)

Gross Profit 190 650 000 96 600 000

Bad Debts (5 100 000) (4 500 000)

Depreciation (19 800 000) (20 100 000)

Research and development (10 200 000) (11 100 000)

Other operating costs (28 750 000) (26 700 000)

Operating profit 26 800 000 34 200 000

Finance charges (12 750 000) (10 800 000)

Profit before tax 14 050 000 23 400 000

Extracts from the Balance Sheet as of 31 December 2021

2021 2020

R R

Trade receivables 51 000 000 42 900 000

Total assets 279 900 000 264 900 000

Shareholders equity 152 200 000 142 100 000

Bank overdraft 127 500 000 102 800 000

The inventory balance as of 31 December 2021 is R28 060 000

Required:

a)	Evaluate the working capital position and the profitability of Voest ltd for the 2020 and the 2021 financial years		[22 marks]
b)	Evaluate the impact of introducing the settlement discount on the profitability and cash flows of Voest ltd		[15 marks]
c)	Discuss the factors which Voest ltd should take into account in deciding whether to discontinue the manufacture of specialized drilling equipment and purchase the drilling equipment from Steglich ltd		[8 marks]