- 10 Marks
Question
Kaki Limited needs to finance a seasonal bulge in inventories of GH¢400,000. The funds are needed for six months. The company is considering the following possibilities:
i) Warehouse loan received from a finance company. Terms are 12 percent with an 80 percent advance against the value of the inventory. The warehousing costs are GH¢7,000 for the six-month period. The residual financing requirement, which is GH¢400,000 less the amount advanced, will need to be financed by foregoing cash discounts on its payables. Standard terms are 2/10, net 30. However, the company feels it can postpone payment until the fortieth day without adverse effect.
ii) A floating lien arrangement from the supplier of the inventory at an effective interest rate of 20 percent. The supplier will advance the full value of the inventory.
iii) A field warehouse loan from another finance company at an interest rate of 10 percent. The advance is 70 percent, and field warehousing costs amount to GH¢10,000 for the six-month period. The residual financing requirement will need to be financed by foregoing cash discounts on payables as in the first alternative.
Required:
Evaluate the feasible method of financing the inventory needs of the firm.
Answer
The warehouse loan (GH¢35,996) results in the lowest overall cost compared to the floating lien arrangement (GH¢40,000) and the field warehouse loan (GH¢38,694). Therefore, the warehouse loan is the most cost-effective method for financing the inventory needs of the firm.
- Topic: Sources of finance and cost of capital
- Series: MAY 2019
- Uploader: Theophilus