Question

Network Solutions just introduced a​ new, fully automated manufacturing plant that produces 1,500 wireless routers per day with materials costs of $50 per router and no other costs. The average number of days a router is held in inventory before being sold is 54 days. In​ addition, they generally pay their suppliers in 27 ​days, while collecting from their customers after 26 days.

How much would working capital be reduced if they stretched their payments to suppliers from 27 days to 47 ​days?

Answer 1

1. Days Sales of Inventory (DSI) = 54
(No. of days taken to turn the inventory into sales)

2. Days Sales Outstanding (DSO)= 26
(No. of days till when payment comes for the sale made)

3. Days Payable Outstanding (DPO) = 27
(no. of days till when payment to the suppliers can be made)

Production = 1500 routers per day.
Cost per router = $50

Considering (3) we have DPO = Average Account Payable / COGS

Thus 27 = Average Account Payable / (1500 x $50)
Thus Average Account Payable = 2,025,000

Working Capital = Account Receivable + Inventory - Account Payable

We have "Account Receivable" & "Inventory " as constant as there is no change there.

Thus if we change DPO from 27 to 47 we have

DPO = Average Account Payable / COGS

Thus 47 = Average Account Payable / (1500 x $50)
Thus Average Account Payable = 3,525,000

Thus Working capital would be reduced by = (3,525,000 - 2,025,000) = 1,500,000

Thus since we have "Account Receivable" & "Inventory " as constant as there is no change there, Working capital would be reduced by = 1,500,000