Question

1.  Problem 15.01 (Cash Conversion Cycle)

Parramore Corp has $11 million of sales, $1 million of inventories, $2.25 million of receivables, and $1.25 million of payables. Its cost of goods sold is 85% of sales, and it finances working capital with bank loans at an 8% rate. Assume 365 days in year for your calculations. What is Parramore's cash conversion cycle (CCC)? Do not round intermediate calculations. Round your answer to two decimal places. days 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 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? Write out your answer completely. For Example, 13.2 million should be entered as 13,200,000. Do not round intermediate calculations. Round your answer to the nearest dollar. $   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? Write out your answer completely. For Example, 13.2 million should be entered as 13,200,000. Do not round intermediate calculations. Round your answer to the nearest dollar. $

Answer 1

1)

Cash conversion cycle (CCC) = Days inventory outstanding (DIO) + Days sales outstanding (DSO) - Days payable outstanding (DPO)

Days inventory outstanding (DIO) = (Inventory / COGS) *365 = (1 / (85%*11))*365 = 39.0374

Days sales outstanding (DSO) =  (Accounts receivable / Total credit sales) * 365 = (2.25/11)*365 = 74.6591

Days payable outstanding (DPO) = (Accounts payable / COGS) * 365 = (1.25/(85%*11)*365 = 48.7968

Cash conversion cycle (CCC) = 39.0374 + 74.6591 - 48.7968 = 64.8997

CCC is 65 days

2) Inventories reduced by 11%, Inventory = $1 million *(1-9%) = $ 0.91 million

Receivables reduced by 11%, Receivable = $ 2.25 million *(1-9%) = $ 2.0475 million

Payable increased by 11%, Payable = $1.25 million*(1+9%) = $ 1.3625 million

Cash conversion cycle (CCC) = Days inventory outstanding (DIO) + Days sales outstanding (DSO) - Days payable outstanding (DPO)

Days inventory outstanding (DIO) = (Inventory / COGS) *365 = (0.91 / (85%*11))*365 = 35.5241

Days sales outstanding (DSO) =  (Accounts receivable / Total credit sales) * 365 = (2.0475/11)*365 = 67.9398

Days payable outstanding (DPO) = (Accounts payable / COGS) * 365 = (1.3625/(85%*11)*365 = 53.1885

Cash conversion cycle (CCC) = 35.5241 + 67.9398- 53.1885 = 50.2754

CCC is 51 days

3) Cash Freed up = Cash freed up for inventory + Cash freed up for receivable + Cash freed up for payable

Cash freed up for inventory = Earlier Inventory - Inventory after reduction = 1-0.91 = 0.09 million = $90,000

Cash freed up for receivable = Earlier Receivable - Receivable after reduction = 2.25 - 2.0475 = 0.44 million = $202,500

Cash freed up for payable = Earlier payable - payable after reduction = 1.25 - 1.3625 = 0.1125 million = $112,500

Cash Freed up = $90,000 + $202,500 + $112,500 = $405,000

4) Pretax profit from freed up capital = $405,000 * 8% = $32,400

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