Question

D.Next year DOGGI Ltd forecasts a cash requirement of K1.6milion, the use being constant throughout the year. The company has investments in excess of this amount which are earning 10.5% p.a. The company earns interest of 6% on their current account bank balance. The cost of selling investments is K150 per transaction

i)If the company sells K150,000 of investments each time, calculate the total cost p.a. to the company.
ii)What is the optimal economic quantity of cash to transfer each time in order to minimise costs?
c) Explain how the financing of working capital can be arranged in terms of short and long term sources of finance. In particular, make reference to:
i)The financing of working capital or net current assets when short term sources of finance are exhausted
ii)The distinction between fluctuating and permanent current assets.d.

Answer 1

To find the total cost per annum of selling investments for DOGGI Ltd, divide the annual cash requirement by the amount per transaction and multiply by the transaction cost. The optimal economic quantity of cash to transfer minimizes the total cost, accounting for interest earnings and transaction fees. Working capital can be financed via short-term or long-term sources, with the choice depending on whether the company is financing fluctuating or permanent needs.

Step-by-step explanation:

When DOGGI Ltd forecasts a cash requirement of K1.6 million and plans to sell K150,000 of investments each time, they incur a transaction cost of K150 per sale. To calculate the total cost per annum (p.a.) to the company, we divide the annual cash requirement by the amount sold per transaction and multiply by the cost per transaction: (K1,600,000 / K150,000) * K150.

The optimal economic quantity of cash to transfer each time, also known as the Economic Order Quantity (EOQ), would be determined using the formula that minimizes the total cost of holding cash and transaction costs for selling investments. For DOGGI Ltd, these costs include the opportunity cost of earning less interest on the cash balance, the earning from investments, and the cost of transactions.

In terms of arranging the financing of working capital, short-term sources might include trade credit, bank loans, or commercial paper, used specifically for financing short-term or temporary needs. When these sources are exhausted, a company may turn to long-term financing options such as long-term loans, issuing bonds, or equity financing to fund permanent or long-term working capital needs. Fluctuating current assets refer to those that vary with seasonal or production cycles, whereas permanent current assets are the minimum level of current assets a firm needs to continue operations.