I know that This question was asked before however the lastsection is incorrect.
ID: 2662251 • Letter: I
Question
I know that This question was asked before however the lastsection is incorrect. Please clarify the Last section for me. Primrose Corp has $15 million of sales, $2 million ofinventories, $3 million of receivables, and $1 million of payables.Its cost of goods sold is 80 percent of sales, and it financesworking capital with bank loans at an 8 percent rate. What isPrimrose’s cash conversions cycle(CCC)? If Primrose couldlower its inventories and recivables by 10 percent each andincrease its payable by 10 percent, all without affecting eithersales or cost of goods sold, what would the new CCC be, how muchcash would be freed up, and how would that affect pre-taxprofits? how much cash would be freed up(This was stated to be 400,000 which is notcorrect). I know that This question was asked before however the lastsection is incorrect. Please clarify the Last section for me. Primrose Corp has $15 million of sales, $2 million ofinventories, $3 million of receivables, and $1 million of payables.Its cost of goods sold is 80 percent of sales, and it financesworking capital with bank loans at an 8 percent rate. What isPrimrose’s cash conversions cycle(CCC)? If Primrose couldlower its inventories and recivables by 10 percent each andincrease its payable by 10 percent, all without affecting eithersales or cost of goods sold, what would the new CCC be, how muchcash would be freed up, and how would that affect pre-taxprofits? how much cash would be freed up(This was stated to be 400,000 which is notcorrect).Explanation / Answer
Cash conversion cycle =Inventory conversion period +Receivables collection period - Payables deferral period Receivables collection period = Receivables/(Sales/365) Inventory conversion period = Inventory/(Sales/365) Payables deferral period = Payables/(CoGS/365) Scenario 1. Primrose Corp has $15 millionof sales, $2 million of inventories, $3 million of receivables, and$1 million of payables. Its cost of goods (COGS) sold is 80 percentof sales, So COGS = 80%*15M = $12M Putting values, we get Receivables collection period = Receivables/(Sales/365) =3M/(15M/365)= 73 days Inventory conversion period = Inventory/(Sales/365) = 2M/(15M/365)= 48.7days Payables deferral period = Payables/(CoGS/365)= 1M/(12M/365) = 30.4days Cash conversion cycle =Inventory conversion period +Receivables collection period - Payables Deferral period ie Cash conversion cycle = 48.7+73 -30.4= 91.3 days Scenario 2. If Primrose could lower itsinventories and recivables by 10 percent each and increase itspayable by 10 percent, all without affecting either sales or costof goods sold. SO here Sales remain at $15M. So COGS = 80%*15M = $12M Inventories lowered by 10% = $2M - $2M*10% = $1.8M Receivables lower by 10% = $3M = $3M*10% = $2.7M Payables increase by 10% = $1M +10%*1M = $1.1M Its cost of goods (COGS) sold is 80 percent of sales, So COGS =80%*15M = $12M Putting values, we get Receivables collection period = Receivables/(Sales/365) =2.7M/(15M/365)= 65.7days Inventory conversion period = Inventory/(Sales/365) =1.8M/(15M/365) = 43.8days Payables deferral period = Payables/(CoGS/365)= 1.1M/(12M/365) =33.5 days New Cash conversion cycle =Inventory conversion period+ Receivables collection period - Payables Deferral period ie New Cash conversion cycle = 43.8 +65.7-33.5= 76days Thus CC cycle has reduced from 91.3 days to 76 days i.e by(91.3-76) = 15.3 days. We also know that Net Working Capital (NWC) = Acct Rxable +Inventory - Acct Payable In Sceneario 1, NWC = 3M+2M-1M=4M In Scenario 2, NWC = 2.7M+1.8M-1.1M= 3.4M Thus NWC has reduced by (4M-3.4M)=0.6M = $600,000 due toreduction in CC by 15.3 days.As cost of BankLoan is 8% pa, an Amount of 600,000*8%= $48,000 is saved in termsof Interest which is added to pre-tax profit.