QUESTION ONE

Wema Ltd has estimated that the standard deviation of its daily net cash flows is Sh.2,500. The firm pays Sh.50 in transaction costs to transfer funds into and out of this money market. The rate of interest in the money market is 7.465% p.a. Wema uses the Miller-Orr Model to set its target cash balances.

Required

1. What is Wema’s target cash balance?

2. What are the lower and upper cash limit?

3. What are the Wema’s decision rules?

4. Determine Wema’s expected average cash balance.

QUESTION TWO

Mama Star Enterprises is a distributor or air filters to retail shops. It buys its filters from several manufacturers. Filters are ordered in lot sizes of 100 and each order costs Sh.400 to place. Demand from retail shops is 200,000 filters per month and the carrying cost is Sh.10 per filter per month.

Required

1. What is the optimal order quantity with respect to so many lot sizes”

2. If a safety stock of 2,000 filters is desired what is the total relevant costs?

3. A certain manufacturer offers a discount of 2% for purchases of 50 lot sizes or more. Should the discount be taken? (Assume that each filter costs Sh.100).

QUESTION THREE

Willie Distributors Ltd. uses discriminant analysis in customer classification. A good customer is defined as one who pays on or before the due date while a bad customer is one who does not meet this standard.

The finance director believes that the two most important ratios in discriminating between a good and bad customer are the current ratio and the returns on investment (i.e. Earnings Before Interest and taxes divided by total assets), Y.

Data relating to 20 accounts (consisting of 10 good and 10 bade) is shown beloW

Good account                                Bad accounts

1.1 1.5 1.2 0.9 1.6 2.2 0.9 1.0 1.3 1.3

13 15 15 21 7 8 16 13 8 2

0.7 0.9 0.8 1.3 1.1 0.5 0.3 1.4 0.9 1.1

11 -4 6 2 6 8 8 6 3 14

Required

Estimate the discriminant function using the above data.

Use the discriminant function to find the Z score for each of the twenty accounts

Determine a Z score that minimises the number of misclassifications.

(CPA pilot paper)

QUESTION FOUR

a) Explain why proper working capital management is important for the financial success of a company.

b) At a recent seminar on “Gender Empowerment in Business’ the invited financial consultant, Madame Hesabu Advised the participants that extending credit is one of the comerstone of modern business. Madame Biashara, the managing director of Biashara Limited took note of this important fact. After the seminar, she authorised a review of the credit system of her company. The following facts are relevant.

(8 marks)

1. Annual sales of the company are Sh.5,000,000

2. Credit sales are 25 per cent of all sales

3. Bad debts average 2% of all credit sales

4. Average collection period for debtor is 40 days

5. The company’s cost of capital is 14 per cent per annum

6. Net profit on sales is 15 per cent.

Based on these facts, she is recommending a thorough revamping of the credit policy of the company. The expected outcome of this action will be:

1. Increase in total sales by 30 per cent

2. Credit sales will be 40 per cent of all sales

3. Average collection period will decrease to 35 days

4. Bad debts will increase to 3 per cent of credit sales

5. An additional part time credit control assistant will be hired for Sh.50,000 per annum.

Required

The effectiveness or otherwise of the proposed revamping of credit policy. (Show all your workings). (8 marks)

Who should determine credit policy? (2 marks)

(Total: 18 marks)