State any two stages of the working capital cycle.

Calculate for GT:

the payback period for the €44 million investment in new equipment based on the forecasted increase in net cash flow (show all your working).

Calculate for GT:

the average rate of return (ARR) based on an annual increase in net cash flow of €6000 and assuming an asset life of the new equipment of eight years (show all your working).

With reference to GT, explain one advantage and one disadvantage of debt factoring.

Examine Elaine’s proposals to cut back on GT’s commitment to its employees and CSR practices.

Typically, stages of the working capital cycle include:

• purchase of materials from suppliers
• production of goods
• goods sold, typically on credit (unless a retail store)
• payment received by debtors.

Candidates are not expected to label the stages exactly as above. These responses may be brief and still get marks. Candidates need merely state the stages with no further description or elaboration.

Award [1] for each stage of the working capital cycle stated up to a maximum of [2].

Payback period $=\frac{\text{initial investment costs}}{\text{Annual cash flow from investment}}=\frac{\text{€ }44000000}{\text{€ }8000000}$

                      = 5.5 years

Award [1] for working and [1] for the correct answer, up to a maximum of [2].

Average rate of return (ARR) $=\frac{\left(\text{Total returns}-\text{total cost}\right)}{\frac{\text{years of usage}}{\text{capital cost}}}\times 100$

$\frac{\left(48000000-44000000\right)}{\frac{8}{44000000}}\times 100=1.14\text{\% }$   Accept 1.1%

Award [1] for working and [1] for the correct answer, up to a maximum of [2].

Advantages of debt factoring. The business (GT):

• does not have to carry the invoice (receivable) for the duration (or longer) of the credit terms but rather receives cash immediately upon sale to the factor. Thus, factoring reduces the working capital requirements.
• does not have to provide any collateral. Unlike when taking out a revolving or seasonal line of credit, the business does not have to provide a lender with collateral. As a result, the business may use any assets it has available for collateral for other borrowing requirements.
• does not have the credit risk of the debtor, as the factor assumes the credit risk (though, over time, if GT routinely sold uncollectable invoices, the factor would adjust its discount rate to account for credit losses or not purchase invoices from certain customers). Without the credit risk, the business does not have to have a collections employee/department and will not have credit losses.

The disadvantages of factoring include:

• The high cost. While the discount rate may vary, the discount rate used by debt factors almost always equates to a higher rate of interest than a loan. Thus, the cost of debt factoring is high.
• Loss of control. Collection of the invoice is in the hands of the factor, who may or may not use collection methods consistent with the approach of the business selling the invoices. Customer relations could suffer if the factor uses harsh collection methods or a negative tone in collection.
• Damage to reputation. In general, some stigma is attached to reliance on debt factors, as it alerts customers that the business (GT) lacks working capital or the ability to borrow. A poor reputation weakens a firm’s ability to negotiate and may mean loss of customers (businesses want suppliers who are reliable).

Accept other relevant advantages and disadvantages.

Mark as 2 + 2.

Accept any other relevant advantage / disadvantage.

Accept any other relevant explanation.

Mark as 2 + 2.

Award [1] for each correct advantage / disadvantage identified or described and [1] for a relevant explanation with application to GT. Award up to a maximum of [2].

[2] cannot be awarded per advantage / disadvantage if the response lacks either explanation and / or application.

For example:

• For an identification or a description of an advantage / disadvantage with or without application [1].
• For explanation of an advantage / disadvantage with no application [1].
• For explanation of an advantage / disadvantage and application [2].

The main thrust of this question is for candidates to consider the difficult financial situation that GT has gotten itself into and how the company may try to resolve the issue. The CFO’s idea to cut back on GT’s commitments to employees and to CSR rests on the notion that commitments to employees and CSR are costly and that saving those expenses could help pay for the commitment and generate profits to support much needed working capital. However, the stimulus makes clear that commitments to employees and CSR are core values of the company and possibly the very basis for the success of the company. To eliminate them or weaken them may cause other (costly) issues for the business.

Candidates should distinguish between commitments to employees and commitments to CSR. Cutting commitments to employees would erode trust and loyalty, bringing long-term damage to the company, whereas cutting CSR for a
short period of time is more justifiable and explainable. Candidates may want to propose other solutions – selling assets, other sources of finance, etc.

Balance in the context of this question means nuanced advantages and disadvantages of cutting back on GT’s commitments to employees and to CSR. If candidates do not treat commitment to employees and commitment to CSR separately, award a maximum of [7].

Candidates are expected to provide conclusions and judgment.

Accept any other relevant answer.

Marks should be allocated according to the SL Paper 2 markbands on page 5 with further guidance below.

A balanced response is one that provides at least two arguments for and two arguments against the proposal.

For one relevant issue that is one-sided, award up to [3]. For more than one relevant issue that is one-sided, award up to a maximum of [4].

Award a maximum of [6] if the answer is of a standard that shows balanced analysis and understanding throughout the response with reference to the stimulus material but there is no judgment/conclusion.

Candidates cannot reach the [7–8] markband if they give judgment/conclusions that are not based on analysis/explanation already given in their answer.

If a candidate does treats the two issues as one, maximum award [4].