(a) Current annual profit, ignoring bad debts = (45% × GH¢8 million) – GH¢2.5 million = GH¢1.1 million.
Current receivables = GH¢8 million × 45 / 365 = GH¢986,301

With the discount policy:
(1) Expected average time to pay = 25% × 14 days + 75% × 60 days = 48.5 days.
(2) Annual sales = GH¢8 million × 1.03 = GH¢8.24 million.
(3) Average receivables = GH¢8.24 million × 48.5 / 365 = GH¢1,094,901.

If all the estimates are correct the discount policy will increase annual profit by about GH¢24,000. This is a fairly small amount in relation to the company’s annual profits of GH¢1 million after bad debts, and management should consider the reliability of the estimates before deciding whether or not to introduce the discount policy. The expected increase in total annual sales would seem to be a key estimate.

By improving the collection of receivables and reducing the average collection period to the expected current 30 days, the company could reduce average receivables by GH¢328,767 (GH¢8 million × 15 / 365) and this would reduce annual interest costs (at 8%) by about GH¢26,300 per year – more than the expected benefit from the discount policy.

(b) It is assumed that the volatility of daily cash flows will continue the same as in the past.
Standard deviation of cash flows per day = GH¢2,800
Variance of daily cash flows = GH¢(2,800)^2 = GH¢7,840,000.
Annual interest yield on investments = 5.68%
Daily interest yield on investments = 5.68% / 365 = 0.0155616%

Using the Miller-Orr model, the spread should be:
= 3 × GH¢9,108.6 = GH¢27,326.

Minimum cash balance = GH¢12,500
Spread = GH¢27,326
Upper limit = GH¢12,500 + GH¢27,326 = GH¢39,826
Return point = GH¢12,500 + (1/3 × GH¢27,326) = GH¢21,609.

In practice, the spread and the return point might be rounded to a convenient whole number.
The Miller-Orr model can be used to manage holdings of cash (that do not earn interest) and short-term interest-yielding investments when there is uncertainty about the amount of daily cash flows. The aim is to optimise investment yield and minimise the need to hold cash, whilst at the same time trying to avoid a situation in which there are no cash holdings to meet the need for operational payments (because all available cash has been used to buy investments or has been put in an interest-yielding deposit account). The company has established a minimum cash holding as a matter of policy. It will manage its cash so that cash holdings do not become too high. When cash holdings exceed the upper cash limit of GH¢39,826, some cash will be invested in interest-earning investments. The amount of cash invested will be an amount to reduce cash holdings to the return point of GH¢21,609.
When cash holdings fall to the minimum cash balance, some investments will be sold to restore the amount of cash held. The amount of investments sold should be sufficient to restore cash holdings to the return point.

(c) The company would invest its surplus cash in investments that provide some interest yield. Normally, the company would want the investments to be convertible into cash at fairly short notice and without any significant risk of capital loss.

A bank might be willing to offer cash deposit facilities, although there might be a penalty payment if cash is withdrawn without a minimum notice period. A bank might not want to provide a bank deposit facility to a corporate customer if the company intends to withdraw cash regularly.

An alternative would be to invest in short-term money market instruments such as Treasury bills or short-dated government bonds. These can be sold at short notice although there would be some risk of capital loss (in the event that interest rates rise).

The company is unlikely to invest surplus cash in short-term equities if it wants to avoid the risk of capital losses.

(d) The company should have a basic policy towards the funding of its assets. It is possible to categorise assets into three types: non-current assets, permanent current assets and temporary current assets. Permanent current assets are the minimum amount of current assets that the company has at any time. Temporary current assets are the surplus of current assets at any time above the minimum amount.
The company might have a policy of matching. This means that it would seek to finance its non-current assets and permanent current assets with long-term funds (equity and short-term debt) and to finance temporary current assets with short-term funds (bank overdraft and trade payables).
Alternatively the company might have a more conservative funding policy, and seek to finance some temporary current assets with long-term funds.
A third policy option would be to use short-term sources of finance to fund some permanent current assets as well as temporary current assets. However, when such a policy is too aggressive, there could be a risk of overtrading (financing the business operations with insufficient long-term capital).
Normally, short-term funds are cheaper than longer-term capital. Trade payables, for example, do not have a cost. This means that the more that current assets are financed by short-term funds, the lower should be the interest cost and the larger the company’s profit. The risk with an aggressive funding policy, however, is that the business might have cash flow and liquidity problems if it tries to rely too much on overdraft and trade payables.
The attitude of management toward risk will help to determine whether the business will adopt a matching policy, a conservative funding policy or an aggressive funding policy.
Other factors might need to be considered.
(1) The bargaining power of suppliers. A company cannot rely on short-term credit to fund current assets when suppliers are able to insist on strict credit terms, and will otherwise refuse to supply goods.
(2) The ability of the company to raise long-term capital. Some companies, particularly small companies, have difficulty in obtaining longer-term funding (such as medium-term bank loans) and they might be forced out of necessity to rely on short-term funding from an overdraft and trade payables.