Wire Free plc retails wireless hi-fi systems, which have a selling price of £800 per unit and a purchase price of £400 per unit from its supplier. The company expects the annual demand for its hi-fi systems to be 80,000 units.

 

The company is currently conducting a review of its working capital management and is keen to improve it and hence is considering adopting one of two potential courses of action. The first looks into improving its inventory management and the second improving the management of their accounts receivable. The company currently only has the capacity to introduce one of the two initiatives.

 

(1) Inventory management improvement plan:

Currently the company orders the system in batches of 20,000 at regular intervals throughout the year. Because demand can be volatile at times, the company maintains “buffer stock” of the product sufficient to meet demand for 30 days. The cost of placing an order is £250 per order and the storage cost is £3.50 per unit per year.

 

Here the proposal is to introduce the economic order quantity (EOQ) model to determine its ordering policy.

 

(2) Accounts receivable improvement plan:

Wire Free plc’s customers currently receive 30 day’s credit. However, on average they pay after 45 days. The company also suffers bad debts of 3%.  

 

The proposal here is to introduce a 3% discount for payment after 14 days. It is estimated 25% of their customers would take this offer up. They will also spend £300,000 on collection procedures which will ensure remaining customers pay after 30 days and reduce bad debts to 2%. Sales will be unaffected.

 

Required

(a)       If Wire Free plc has an annual short-term cost of debt of 6%, evaluate which (if either) of the initiatives should be accepted. Assume a 365-day year. 

(b)       If Wire Free plc was to enlist the services of a factor, identify and discuss TWO advantages and TWO disadvantages of this approach to the management of accounts receivable.

Answer rating: 100% (QA)

a The company should adopt the inventory management improvement plan The present value of the inventory management improvement plan is PV 250000 35000... View the full answer