Question

CASH CONVERSION CYCLE

Parramore Corp has $12 million of sales, $3 million of inventories, $2 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 9% rate. Assume 365 days in year for your calculations. Do not round intermediate steps.

1. What is Parramore's cash conversion cycle (CCC)? Do not round intermediate calculations. Round your answer to two decimal places.
     days
2. 
   
3. If Parramore could lower its inventories and receivables by 11% each and increase its payables by 11%, all without affecting sales or cost of goods sold, what would be the new CCC? Do not round intermediate calculations. Round your answer to two decimal places.
     days
4. 
   
5. How much cash would be freed up, if Parramore could lower its inventories and receivables by 11% each and increase its payables by 11%, all without affecting sales or cost of goods sold? Do not round intermediate calculations. Round your answer to the nearest cent. Write out your answer completely. For Example, 13.2 million should be entered as 13,200,000.
   $
6. 
   
7. By how much would pretax profits change, if Parramore could lower its inventories and receivables by 11% each and increase its payables by 11%, all without affecting sales or cost of goods sold? Do not round intermediate calculations. Round your answer to the nearest cent. Write out your answer completely. For Example, 13.2 million should be entered as 13,200,000.
   $

Answer 1

Part (a). CCC = 136.88 days

Formula			Formula
	Sales (S)	12,000,000	I/(COGS/n)	Inventory conversion period (Ip)	114.06
	Inventories (I)	3,000,000	R/(S/n)	Receivables conversion period (Rp)	60.83
	Receivables ('R)	2,000,000	P/(COGS/n)	Payables conversion period (Pp)	38.02
	Payables	1,000,000	Ip + Rp - Pp	Cash Conversion Cycle	136.88
80%*S	COGS	9,600,000
	Days in a year (n)	365

Part (b). If inventory & receivables decrease by 11% and payables increase by 11%: CCC = 113.45 days

Formula			Formula
	Sales (S)	12,000,000	I/(COGS/n)	Inventory conversion period (Ip)	101.52
(1-11%)*Old inventory	Inventories (I)	2,670,000	R/(S/n)	Receivables conversion period (Rp)	54.14
(1-11%)*Old receivables	Receivables ('R)	1,780,000	P/(COGS/n)	Payables conversion period (Pp)	42.20
(1+11%)*Old payables	Payables	1,110,000	Ip + Rp - Pp	Cash Conversion Cycle	113.45
80%*S	COGS	9,600,000
	Days in a year (n)	365

Part (c). Cash freed up:

Cash from change in inventories period = (old conversion period - new conversion period)/(COGS/365)

= (114.06 - 101.52)*(9,600,000/365) = 330,000

Cash from change in receivables period = (old conversion period - new conversion period)/(Sales/365)

= (60.83 - 54.14)*(12,000,000/365) = 220,000

Cash from change in payables period = (new conversion period - old conversion period)/(COGS/365)

= (42.20-38.02)*(9,600,000/365) = 110,000

Total cash freed up = 330,000 + 220,000 - 110,000 = 440,000.00

Part (d). Pretax profit will change by

cash freed up* bank loan rate = 440,000*9% = 39,600.00

Note: As instructed in the question, intermediate calculations have not been rounded off. If the intermediate calculations are rounded off to two decimal places then answers in parts (c) & (d) will differ slightly from the ones given above. So, please check with both sets of answers.