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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

CASH CONVERSION CYCLE Primrose Corp has $15million of sales, $2million of inventories, $3 million of receivables, and $1 million of payables. Its cost of goods sold is 80% of sales, and it finances working capital with bank loans at an 8% rate. What is Primrose’s cash conversion cycle (CCC)? If Primrose could lower its inventories and receivables by 10% each and increase its payables by 10%, all without affecting sales or cost of goods sold, what would be the new CCC, how much cash would be freed up, and how would that affect pretax profits?

Summary Introduction

To determine: The cash conversion cycle of P Company, the new cash conversion cycle when inventories are lowered and receivables by 10%, the amount of cash that would be free up, and its effect on pretax profits.

Cash conversion cycle:

The cash conversion cycle refers to a tool used to measure the effectiveness of the management of a company and the overall health of that company.

Explanation

Calculate the cash conversion cycle of P Company by following the steps given below:

Step 1: Calculate the inventory conversion period.

Inventoryconversionperiod=InventoryCostofgoodssoldperday=2,000,00012,000,000365=2,000,00032876.712=60.83days

Therefore, the inventory conversion period of P Company is 60.83 days.

Step 2: Calculate the average collection period.

Averagecollectionperiod=ReceivablesSales/365=3,000,00015,000,000/365=73days

Therefore, the average collection period is 73 days.

Step 3: Calculate the payables deferral period.

Payables deferral period=PayablesCostofgoodssold/365=1,000,00012,000,000365=1,000,00032876.7123=30.42days

Therefore, the payables deferral period is 30.42 days.

Step 4: Calculate the cash conversion cycle.

Cashconversioncycle=60.83+73+30.42=103.41days

Therefore, the cash conversion cycle is 103.41 days.

Calculate the new cash conversion cycle by following the steps given below.

Step 1: Calculate the inventory conversion period.

Inventoryconversionperiod=InventoryCostofgoodssoldperday=1,800,00032,876

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