ExpertMedium2 marksShort Answer
ACCA · Question 16.1 · Working Capital Management
CASE 1: AQUAHARVEST LTD
AquaHarvest Ltd is a commercial aquaculture firm farming premium salmon. The company currently allows its wholesale customers 60 days to pay their invoices. However, due to cash flow constraints, the Finance Director is considering offering an early settlement discount of 2% if customers pay within 15 days. AquaHarvest currently finances its working capital using a bank overdraft that charges an interest rate of 8% per annum. Assume a 365-day year.
Calculate the effective annualized cost of offering the early settlement discount.
(Enter your answer as a percentage to one decimal place, e.g., 15.5. Do not include the % sign)
CASE 1: AQUAHARVEST LTD
AquaHarvest Ltd is a commercial aquaculture firm farming premium salmon. The company currently allows its wholesale customers 60 days to pay their invoices. However, due to cash flow constraints, the Finance Director is considering offering an early settlement discount of 2% if customers pay within 15 days. AquaHarvest currently finances its working capital using a bank overdraft that charges an interest rate of 8% per annum. Assume a 365-day year.
Calculate the effective annualized cost of offering the early settlement discount.
(Enter your answer as a percentage to one decimal place, e.g., 15.5. Do not include the % sign)
How to approach this question
Use the formula: Annualized Cost = [(1 + (Discount / (100 - Discount))) ^ (365 / Days saved)] - 1.
Full Answer
1. Discount = 2%
2. Amount left to pay = 100% - 2% = 98%
3. Interest rate for the period = 2 / 98 = 0.020408
4. Days saved = 60 - 15 = 45 days
5. Number of periods in a year = 365 / 45 = 8.1111
6. Annualized cost = (1 + 0.020408)^8.1111 - 1 = 1.178 - 1 = 0.178 or 17.8%.
Common mistakes
Using 365/15 or 365/60 instead of the days saved (45).
Practice the full ACCA FM — Financial Management Practice Exam 3
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