Question

CASH CONVERSION CYCLE

Parramore Corp has $15 million of sales, $3 million of inventories, $2 million of receivables, and $3 million of payables. Its cost of goods sold is 65% of sales, and it finances working capital with bank loans at an 8% 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 9% each and increase its payables by 9%, 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 9% each and increase its payables by 9%, 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 9% each and increase its payables by 9%, 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

Sales = $15,000,000

Inventory = $3,000,000

Accounts Receivable = $2,000,000

Accounts Payable = $3,000,000

Cost of Goods Sold = 65% of Sales = 65% x 15,000,000 = $9,750,000

a) Cash Conversion Cycle

To work Cash conversion cycle we need to work out Daily Inventory Outstanding, Daily Sales Outstanding and Daily Payable Outstanding

Daily Inventory outstanding (DIO)= (Inventory/Cost of Goods Sold)*365 = 3000000/ 9750000*365 =112.31

Daily Sales Outstanding (DSO)= (Accounts receivable/Annual Sales)*365 = 2000000/15000000*365 = 48.67

Daily Payable Outstanding (DPO) = Accounts payable/Cost of Goods sold)*365 = 3000000/9750000*365 = 112.31

Cash Conversion Cycle = DIO+DSO-DPO = 112.31+48.67-112.31 = 48.67

b) Cash Conversion Cycle if Inventory and Receivable are lowered by 9% and Payables increased bv 9%

Based on given data Revised number would be as follows:

Revised Inventory = 3000000 x(1-9%) = 3000000*91% = 2730000

Revised Receivable =2000000 x(1-9%) = 2000000*91% = 1820000

Revised Payable = 3000000 x(1+9%) = 3000000*109% = 3270000

Revised DIO = (Revised Inventory/Cost of Goods Sold) x 365 = 2730000/9750000*365 = 102.20

Revised DSO = (Revised Accounts Receivable/Annual Sales)x 365 = 1820000)/15000000*365 = 44.29

Revised DPO = (Revised Accounts Payable/Cost of Goods Sold) x 365 = 3270000/9750000*365 = 122.42

Revised Cash Conversion Cycle = 102.20+44.29-122.42 = 24.0

c) Cash that will be freed up

The working capital status under original and revised would be as follows:

Particulars	Original (a)	Revised (b)	Difference (a-b)
Current Assets (CA)
Inventory	3,000,000	2,730,000	270,000
Receivable	2,000,000	1,820,000	180,000
Total CA	5,000,000	4,550,000	450,000
Current Liabilities (CL)
Payable	3,000,000	3,270,000	(270,000)
Total CL	3,000,000	3,270,000	(270,000)
Working Capital (CA-CL)	2,000,000	1,280,000	720,000

Based on above working, working capital amount that will be freed up is $720,000

d) Amount by which pretax profit will increase

From the above workings it can be seen that working capital that will be freed up is $720,000. To that extent Parramore Corp will take less working capital loan. Savings on account of this would be interest saved on this Working capital loan.

= $720,000 x 8%

= $57,600