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In: Finance

Multiple changes in cash conversion cycle   Garrett Industries turns over its inventory 6 times each​ year;...

Multiple changes in cash conversion cycle   Garrett Industries turns over its inventory 6 times each​ year; it has an average collection period of 44 days and an average payment period of 27 days. The​ firm's annual sales are $3.4 million. Assume there is no difference in the investment per dollar of sales in​ inventory, receivables, and​ payables; and a 365​-day year.

a. Calculate the​ firm's cash conversion cycle​, its daily cash operating​ expenditure, and the amount of resources needed to support its cash conversion cycle.

b. Find the​ firm's cash conversion cycle and resource investment requirement if it makes the following changes simultaneously. ​(1) Shortens the average age of inventory by 7 days. (2) Speeds the collection of accounts receivable by an average of 11 days.​(3) Extends the average payment period by 9 days.

c. If the firm pays 9​% for its resource​ investment, by how​ much, if​ anything, could it increase its annual profit as a result of the changes in part b​?

d. If the annual cost of achieving the profit in part c is ​$35,000​, what action would you recommend to the​ firm? ​ Why?

Solutions

Expert Solution

a. Calculate the​ firm's cash conversion cycle​, its daily cash operating​ expenditure, and the amount of resources needed to support its cash conversion cycle.

firm's cash conversion cycle = Average Collection Days + Inventory Days - Average Payment Days

firm's cash conversion cycle = 44 + 365/6 - 27

Firm's cash conversion cycle = 77.83 days or 78 Days

Daily cash operating​ expenditure = Annual Sales / Number of Days = $3400000 / 365 = $9315.07

Amount of resources needed to support its cash conversion cycle = Daily Cash Expenditure * Cash conversion cycle = $9315.07 * 78 = $726575.34

b. Find the​ firm's cash conversion cycle and resource investment requirement if it makes the following changes simultaneously. ​(1) Shortens the average age of inventory by 7 days. (2) Speeds the collection of accounts receivable by an average of 11 days.​(3) Extends the average payment period by 9 days.

New Cash Conversion Cycle = Average Collection Days + Inventory Days - Average Payment Days

New Cash Conversion Cycle = 33 Days + 54 Days - 36

New Cash Conversion Cycle = 51 Days

Daily cash operating​ expenditure = Annual Sales / Number of Days = $3400000 / 365 = $9315.07

Amount of resources needed to support its cash conversion cycle = Daily Cash Expenditure * Cash conversion cycle = $9315.07 * 51 = $475068.49

c. If the firm pays 9​% for its resource​ investment, by how​much, if​ anything, could it increase its annual profit as a result of the changes in part b​?

Increase in Profit = Reduction in expenditure * Rate of Interest

Increase in Profit = (726575.34 - 475068.49) * 9%

Increase in Profit = $22635.62

d. If the annual cost of achieving the profit in part c is ​$35,000​, what action would you recommend to the​ firm? ​ Why?

The action is not recommended as the profit the company(22635.62) is achieving is less than expenses(35000) made for such achievement.

Please upvote

jeff jeffy answered 1 year ago
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