Cash conversion cycle Primrose Corp has $16 million of sales, $3 million of inve

Question

Cash conversion cycle

Primrose Corp has $16 million of sales, $3 million of inventories, $3 million of receivables, and $1 million of payables. Its cost of goods sold is 85% of sales, and it finances working capital with bank loans at an 9% rate. Assume 365 days in year for your calculations. Round intermediate steps to 2 decimal places.

a. What is Primrose's cash conversion cycle (CCC)? Round your answer to two decimal places.

________days ( I worked this portion and the correct answer is 122.11 days)

b. If Primrose could lower its inventories and receivables by 7% each and increase its payables by 7%, all without affecting sales or cost of goods sold, what would be the new CCC? Round your answer to two decimal places.

________days (I worked this portion and the correct answer is 109.81 days)

c. How much cash would be freed-up? Round your answer to the nearest cent.

$____________ (I'm doing something wrong here, please help)

d. By how much would pre-tax profits change? Round your answer to the nearest cent.

$_____________   (I'm doing something wrong here, please help)

Explanation / Answer

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Primrose Corp has $15 million of sales, $2 million inventories, $3 million of receivables, and $1 million of payables. Its cost of goods sold is 80% of sales, and it finances working capital with bank loans at an 8% rate. What is Primroses cash conversion cycle (CCC)? If Primrose could lower its inventories and receivables by 10% each and increase its payables by 10%, all without affecting sales or cost of goods sold, what would be the new CCC, how much cash would be freed up, and how would that affect pre-tax profits?

Answer

a) Cash Conversion Cycle (CCC) is a metric that expresses the length of time, in days, that it takes for a company to convert resource inputs into cash flows. The cash conversion cycle attempts to measure the amount of time each net input dollar is tied up in the production and sales process before it is converted into cash through sales to customers. This metric looks at the amount of time needed to sell inventory, the amount of time needed to collect receivables and the length of time the company is afforded to pay its bills without incurring penalties.

It is calculated as: DIO+DSO-DPO
Where:
DIO represents days inventory outstanding
DSO represents days sales outstanding
DPO represents days payable outstanding

So CCC= Inventory/(COGS/365) + Accounts Receivable/(Sales/365) Accounts Payable/(COGS/365)
ie CCC = $2M/(80%*$15M/365) + $3M/($15M/365) - $1M/(80%*$15M/365)
ie CCC = 60.83+73-30.42
ie CCC = 103.41 days

b. Inv = $2M so new Inv = $2M*(1-10%) = $1.8M
Acct Rx = $3M, New Acct Rx = $3M*(1-10%) = $2.7M
Acct Payable = $1M, New Acct Payable = $1M*(1+10%) = $1.1M
So New CCC= Inventory/(COGS/365) + Accounts Receivable/(Sales/365) Accounts Payable/(COGS/365)
ie CCC = $1.8M/(80%*$15M/365) + $2.7M/($15M/365) - $1.1M/(80%*$15M/365)
ie CCC = 54.75+65.7-33.46
ie CCC = 86.99days

c. Orig working capoital WC = CA-CL = Inv+Rxable-Payable = 2+3-1=$4M
So Int payment = 8% of WC = 8%*$4M = $0.32M
New WC = 1.8+2.7-1.1 = $3.4M
So Int payment = 8% of WC = 8%*$3.4M = $0.272M
So amount of Cash freed up = change in WC = $4M-$3.4M = $0.6M
Saving in Int paid = $0.32M - $0.272M = $0.048M. Sp Pre-tax profits will be higher by $0.048M

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