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Parramore Corp has $10 million of sales, $1 million of inventories, $3 million of receivables, and...

Parramore Corp has $10 million of sales, $1 million of inventories, $3 million of receivables, and $1 million of payables. Its cost of goods sold is 70% of sales, and it finances working capital with bank loans at an 6% 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. If Parramore could lower its inventories and receivables by 8% each and increase its payables by 8%, 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

  3. How much cash would be freed up, if Parramore could lower its inventories and receivables by 8% each and increase its payables by 8%, 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.
    $

  4. By how much would pretax profits change, if Parramore could lower its inventories and receivables by 8% each and increase its payables by 8%, 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.
    $

Solutions

Expert Solution

a. Cash Conversion Cycle

The cash conversion cycle is a cash flow metric that measures the time taken for a company to convert its investment in inventory and other resource inputs into cash. Thus, it measures how long the company is able to convert its purchases to inventory and sales and then to collections of sales /payment of purchases.

Sales    10,000,000 Given in question
Inventories      1,000,000 Given in question
Receivables      3,000,000 Given in question
Payables      1,000,000 Given in question
Cost of goods sold (% of sales) 70% Given in question
Cost of goods sold      7,000,000 (Sales * 70%)
Bank Loan rate 6% Given in question
Days Sales Outstanding            109.50 (Receivables/Sales*365)
Days Inventory Outstanding              52.14 (Inventories/Cost of goods sold*365)
Days Payable Outstanding              52.14 (Payables/Cost of goods sold*365)
Cash Conversion cycle            109.50 Days Sales Outstanding+Days Inventory Outstanding-Days Payable Outstanding

Cash Conversion cycle is 109.50 days

b. 8% reduction in Inventories & Receivables & 8% increase in Payables :

Inventories lowered by 8%
Revised Inventories          920,000 (Old Inventory (1,000,000)*(100%-8%)
Receivables lowered by 8%
Revised Receivables      2,760,000 (Old receivables (3,000,000)*(100%-8%)
Payables increased by 8%
Revised Payables      1,080,000 (Old payables (1,000,000)*(100%+8%)
Sales    10,000,000 Given in question (no change)
Cost of goods sold (% of sales) 70% Given in question (no change)
Cost of goods sold      7,000,000 (Sales * 70%) (no change)
Days Sales Outstanding            100.74 (Revised Receivables/Sales*365)
Days Inventory Outstanding              47.97 (Revised Inventories/Cost of goods sold*365)
Days Payable Outstanding              56.31 ( Revised Payables/Cost of goods sold*365)
Cash Conversion cycle              92.40 Days Sales Outstanding+Days Inventory Outstanding-Days Payable Outstanding

Revised Cash Conversion Cycle is 92.40 days

c. Cash freed-up

Inventories lowered by 8%
Revised Inventories          920,000 (Old Inventory (1,000,000)*(100%-8%)
Receivables lowered by 8%
Revised Receivables      2,760,000 (Old receivables (3,000,000)*(100%-8%)
Payables increased by 8%
Revised Payables      1,080,000 (Old payables (1,000,000)*(100%+8%)
Cash freed-up from inventories            80,000 Old inventories - Revised inventories
Cash freed-up from receivables          240,000 Old receivables - Revised receivables
Cash freed-up from payaables            80,000 Revised payables - Old Payables
Total Cash freed-up          400,000

Total Cash freed-up is $400,000.

Note:

When there is a reduction in receivables, it means collections from customers has inreased and hence a cash-inflow.

When there is a reduction in inventories, it means more inventories have been sold and hence a cash-inflow.

When there is an increase in payables, it means payments to suppliers have been delayed and hence a cash-inflow.

d. Change in pre-tax profits

When there is a free-up of cash, company will repay its working capital loan to that extent and there will be saving of interest.

Thus, change in pre-tax profits due to saving in interest = Cash-freed-up * Bank loan interest rate =

$400,000*6% = $24,000

Change in pre-tax profits = $24,000


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