Question

Soenen Inc. had the following data for last year (in millions). The new CFO believes that the company could improve its working capital management sufficiently to bring its net working capital and cash conversion cycle up to the benchmark companies' level without affecting either sales or the costs of goods sold. Soenen finances its net working capital with a bank loan at an 8% annual interest rate, and it uses a 365-day year. If these changes had been made, by how much would the firm's pre-tax income have increased?

	Original
	Data	Related CCC	Benchmarks' CCC
Sales	$99,000
Cost of goods sold	$80,000
Inventory (ICP)	$20,000	91.25	38.00
Receivables (DSO)	$16,000	58.99	20.00
Payables (PDP)	$5,000	22.81	30.00
		127.43	28.00

Answer 1

Solution

Cost of goods sold (COGS) = $80,000

Current inventory holding period = Inventory / COGS * 365 = 91.25 days

Inventory holding period to be brought down to 38 days

Putting this in above formula:

38 days = New Inventory / $80,000 * 365

So, new inventory value = 38*80000 / 365 = $8,329

Current Receivables credit period = Receivables / Sales * 365 = 58.99 days

Receivables credit period to be brought down to 20 days

Putting this in above formula:

20 days = New Receivables / $99,000 * 365

So, New Receivables value = 20 * 99,000 / 365 = $5,425

Current Payables credit period = Payables / COGS * 365 = 22.81 days

Payables credit period to be brought up to 30 days

Putting this in above formula:

30 days = New Payables / $80,000 * 365

So, New Payables value = 30 * 80,000 / 365 = $6575

Original Net Working Capital is Inventory + Receivables - Payables = $20,000 + $16,000 - $5000 = $31,000

The new Net Working capital would be = $8,329 + $5,425 - $6575 = $ 7,179

The decrease in the net working capital is = $31,000 - $ 7,179 = $ 23,821

Interest on the loan financing net working capital = 8%

Reduction in interest cost due to the decrease in net working capital = $23,821 * 8% = $ 1,906

So increase in the pre-tax income of Soenen Inc. is $ 1,906 milllion