To determine: The cash conversion cycle, the new cash conversion cycle, the amount of cash that would be freed up and the effect on pretax profits.
Introduction:
Cash Conversion Cycle:
The cash conversion cycle refers to the time period which starts from the production of the products to selling of the products and lasts until the time the customer receives the cash.
Explanation of Solution
Given information:
The amount of sales is $12 million.
The amount of inventories is $3 million.
The amount of receivables is $3.25 million.
The amount of payables is $1.25 million.
Cost of goods sold is 75% of sales.
The rate of interest on bank loans is 8%.
Calculation of the cash conversion cycle:
The formula to calculate the cash conversion cycle is,
Substitute 60.83 days for inventory conversion period, 73 days for the average collection period and 30.41 days for the payables deferral period (refer working note) in the above formula.
The cash conversion cycle is 169.83 days or 170 days.
Now,
The inventories are reduced by 10%.
The receivables are reduced by 10%.
The payables are increased by 10%.
Calculation of the new cash conversion cycle:
The formula to calculate the cash conversion cycle is,
Substitute 109.5 days for inventory conversion period, 88.97 days for the average collection period and 55.76 days for the payables deferral period (refer working note) in the above formula.
The new cash conversion cycle is 143 days.
Calculation of the total amount of cash freed up:
The formula to calculate the total amount of cash freed up is,
Substitute $300,082.14 for cash freed up for inventory, $324,821.89 for cash freed up for accounts receivable and (-$125,013.68) for cash freed up for accounts payable (refer working note) in the above formula.
The total cash freed up is $499,890.35.
Calculation of the pre-tax profit:
The formula to calculate the pre-tax profit is,
Substitute $499,890.35 for the total cash freed up and 8% for the interest rate in the above formula.
The pre-tax profit is $39,991.228.
Working note:
Calculation of the cost of goods sold:
The cost of goods sold is $9,000,000.
Calculation of the inventory conversion period:
The inventory conversion period is 121.67 days.
Calculation of the average collection period:
The average collection period is 98.85 days.
Calculation of the payable deferral period:
The payment deferral period is 50.69 days.
Calculation of the new amount of inventories:
The new amount of inventories is $2,700,000.
Calculation of the new amount of receivables:
The new amount of receivables is $2,925,000.
Calculation of the new amount of payables:
The amount of new payables is $1,375,000.
Calculation of the new inventory conversion period:
The inventory conversion period is 109.5 days.
Calculation of the average collection period:
The average collection period is 88.97 days.
Calculation of the payable deferral period:
The payment deferral period is 55.76 days.
Calculation of the cash freed up for inventory:
The cash freed up for inventory is $300,082.14.
Calculation of the cash freed up for accounts receivable:
The cash freed up for accounts receivables is $324,821.89.
Calculation of the cash freed up for accounts payable is:
The cash freed up for accounts payable is ($125,013.68).
Thus, the cash conversion cycle is 170 days, the new cash conversion cycle is 143 days, the total cash freed up is $499,890.35 and the pre-tax profit is $39,991.228.
Want to see more full solutions like this?
Chapter 15 Solutions
Fundamentals Of Financial Management, Concise Edition (mindtap Course List)
- Strickler Technology is considering changes in its working capital policies to improve its cash flow cycle. Stricklers sales last year were 3,250,000 (all on credit), and its net profit margin was 7%. Its inventory turnover was 6.0 times during the year, and its DSO was 41 days. Its annual cost of goods sold was 1,800,000. The firm had fixed assets totaling 535,000. Stricklers payables deferral period is 45 days. a. Calculate Stricklers cash conversion cycle. b. Assuming Strickler holds negligible amounts of cash and marketable securities, calculate its total assets turnover and ROA. c. Suppose Stricklers managers believe the annual inventory turnover can be raised to 9 times without affecting sale or profit margins. What would Stricklers cash conversion cycle, total assets turnover, and ROA have been if the inventory turnover had been 9 for the year?arrow_forwardOptimal Cash Transfer Barenbaum Industries projects that cash outlays of 4.5 million will occur uniformly throughout the year. Barenbaum plans to meet its cash requirements by periodically selling marketable securities from its portfolio. The firms marketable securities are invested to earn 12%, and the cost per transaction of converting securities to cash is 27. a. Use the Baumol model to determine the optimal transaction size for transfers from marketable securities to cash. b. What will be Barenbaums average cash balance? c. How many transfers per year will be required? d. What will be Barenbaums total annual cost of maintaining cash balances? What would the total cost be if the company maintained an average cash balance of 50,000 or of 0 (it deposits funds daily to meet cash requirements)?arrow_forwardRelaxing Collection Efforts The Boyd Corporation has annual credit sales of 1.6 million. Current expenses for the collection department are 35,000, bad-debt losses are 1.5%, and the days sales outstanding is 30 days. The firm is considering easing its collection efforts such that collection expenses will be reduced to 22,000 per year. The change is expected to increase bad-debt losses to 2.5% and to increase the days sales outstanding to 45 days. In addition, sales are expected to increase to 1,625,000 per year. Should the firm relax collection efforts if the opportunity cost of funds is 16%, the variable cost ratio is 75%, and taxes are 40%?arrow_forward
- Assume that an investment of 100,000 produces a net cash flow of 60,000 per year for two years. The discount factor for year 1 is 0.89 and for year 2 is 0.80. The NPV is a. 0 b. 6,800 c. 1,400 d. (4,000)arrow_forwardBrook Corporation’s free cash flow for the current year (FCF0) was $3.00 million. Its investors require a 13% rate of return on (WACC = 13%). What is the estimated value of operations if investors expect FCF to grow at a constant annual rate of (1) −5%, (2) 0%, (3) 5%, or (4) 10%?arrow_forwardRosanna Corp. has P15million of sales; P2million of inventories; P3million of receivables and P1million of payable. Its cost of sales is 80% of sales, and it finance working capital with bank loans at an 8% rate. What is Rosanna’s cash conversion cycle? If Rosanna could lower its inventories and receivables by 10% each, and increase its payable by 10%, all without affecting sales or cost of sales, what would be the new Cash conversion cycle? Following number 2 above, how much cash would be freed up?arrow_forward
- Parramore Corp has $12 million of sales, $3 million of inventories,$3.25 million of receivables, and $1.25 million of payables. Its cost of goods sold is 75% of sales,and it finances working capital with bank loans at an 8% rate. What is Parramore’s cash conversioncycle (CCC)? If Parramore could lower its inventories and receivables by 10% each andincrease its payables by 10%, all without affecting sales or cost of goods sold, what would bethe new CCC, how much cash would be freed up, and how would that affect pretax profits?arrow_forwardCash conversion cycle American Products is concerned about managing cash effi-ciently. On average, inventories have an age of 80 days, and accounts receivable are collected in 40 days. Accounts payable are paid approximately 30 days after they arise. The firm has annual sales of about $30 million. Goods sold total $20 million, and purchases are $15 million. c. Calculate the amount of resources needed to support the firm’s cash conversion cycle?arrow_forwardPROBLEM The Sandbox's Company has cash needs of P5 million per month. If Sandbox needs more cash, it can sell marketable securities, incurring a fee of P300 for each transaction. If Sandbox leaves its funds in marketable securities, it expects to earn approximately 0.50% per month on their investment. 4. If Sandbox gets a cash infusion of P1 million each time it needs cash, what are the total costs per month associated its cash infusions? Use a number, no decimal value no currency, no space, no commas * 5. If Sandbox gets a cash infusion of P1 million each time it needs cash, how many transactions would be associated with its cash investment? Use a number, no decimal value no currency, no space, no commas * 6. Using the Baumol model, what level of cash infusion minimizes Sandbox’s costs associated with cash? Use a number, no decimal value no currency, no space, no commas. * 7. If Sandbox gets a cash infusion of P1 million each time it needs cash, what are the transactions costs per…arrow_forward
- Whitson Co. is looking for ways to shorten its cash conversion cycle. It has annual sales of $45,625,000, or $125,000 a day on a 365-day basis. The firm's cost of goods sold is 75% of sales. On average, the company has $7,500,000 in inventory, $5,750,000 in accounts receivable, and $2,750,000 in accounts payable. Its CFO has proposed new policies that would result in a 25% reduction in both average inventories and accounts receivable, and a 10% increase in average accounts payable. She also anticipates that these policies would reduce sales by 5%. What effect would these policies have on the company's cash conversion cycle?arrow_forwardProblem The Sandbox's Company has cash needs of P5 million per month. If Sandbox needs more cash, it can sell marketable securities, incurring a fee of P300 for each transaction. If Sandbox leaves its funds in marketable securities, it expects to earn approximately 0.50% per month on their investment. 1. If Sandbox gets a cash infusion of P1 million each time it needs cash, what are the transactions costs per month associated its cash infusions? Use a number, no decimal value no currency, no space, no commas * PLEASE ANSWER THANKS!arrow_forwardCalculate the Operating Cash for this Firm:A new firm, GASFORALL, Co expects to generate Sales of $117,700. GASFORALL has variable costs of $74,800, and fixed costs of $15,300. The per-year depreciation is $3,850 and the tax rate is 35 percent. Given this info: What is the annual operating cash flow?arrow_forward
- Intermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage LearningEBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENT
- Managerial AccountingAccountingISBN:9781337912020Author:Carl Warren, Ph.d. Cma William B. TaylerPublisher:South-Western College Pub