Question 1 Utaco Corporation turns its inventory five times each year, has an av

Question

Question 1

Utaco Corporation turns its inventory five times each year, has an average payment period of 21 days, and has an average collection period of 30 days. The company’s annual sales are R3.6 billion, its cost of goods sold represents 80 percent of sales, and its purchases represent 50 percent of cost of goods sold. Assume a 365-day year.

1.1. Calculate the company’s operating cycle (OC) and cash conversion cycle (CCC). (4)
1.2. Calculate the total resources invested in the company’s CCC. (4)
1.3. Assuming that the company pays 18 percent to finance its resource investment, how much would it increase its annual profits by reducing its CCC by 12 days if this reduction were solely the result of extending its average payment period by 12 days? (6)
1.4. If the 12-day reduction in the company’s CCC in part (1.3) could have alternatively been achieved by shortening either the average age of inventory or the average collection period by 12 days, would you have recommended one of those actions rather than the 12-day extension of the average payment period specified in part (1.3)? Which change would you recommend? Explain (6)

Explanation / Answer

Inventory days = 365 days / Inventory turnover = 365 days / 5= 73 days (a) Operating Cycle= Average Age of Inventories+ Average Collection period = 73 Days+ 30 Days= 103 Days Cash Conversion cycle = Operating Cycle - Average Payment Period = 103 days - 21 days= 82 Days b) Daily Cash operating Expenditure= Annual Sales/365 =3600000000/365= 9863014 Required Resources= Daily CashOperating Expenditure X Cash Conversion Cycle = 9863014X 82 = 808767148 or 0.81 Billion ( C) Additional Profit= Daily Cash Operating Expenditure X Cash Conversion Cycle X Financing rate = 9863014X12 days X 18%= 21304110

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