Question

Moxy Sky Corporation had the following data for the most recent year (in millions). The new CFO believes (1) that an improved inventory management system could lower the average inventory by $4,000, (2) that improvements in the credit department could reduce receivables by $2,000, and (3) that the purchasing department could negotiate better credit terms and thereby increase accounts payable by $2,000. Furthermore, she thinks that these changes would not affect either sales or the costs of goods sold. If these changes were made, by how many days would the cash conversion cycle be lowered?

Original Revised Annual sales: unchanged $110,000 $110,000 Cost of goods sold: unchanged $80,000 $80,000 Average inventory: lowered by $4,000 $20,000 $16,000 Average receivables: lowered by $2,000 $16,000 $14,000 Average payables: increased by $2,000 $10,000 $12,000 Days in year 365 365

Select the correct answer: a. 34.0 b. 37.4 c. 41.2 d. 49.8 e. 45.3

Answer 1

The formula for calculating the Cash conversion cycle is

CCC = DIO + DSO – DPO

DIO = (Average inventory / Cost of goods sold) * 365

Original DIO = ($20,000/$80,000) *365 =91.25 days

Revised DIO= ($16,000/$80,000 *365) = 73 days

DPO = (Accounts payable / Cost of goods sold) * 365

Original DPO =($10,000/$80,000)*365 = 45.625 days

Revised DPO = ($12,000/$80,000) *365 = 54.75 days

DSO = (Total receivables / Total credit sales) * 365

Original DSO = ($16,000/$110,000 *365) = 53.09 days

Revised DSO = ($14,000/$110,000 *365) = 46.45 days

CCC = DIO + DSO – DPO

Original CCC = 91.25 + 53.09 – 45.63 = 98.71 days

Revised CCC = 73 + 46.45 – 54.75 = 64.7 days

Total impact = original CCC – Revised CCC = 98.71 – 64.7 = 34.01 days

So, cash conversion cycle will be lowered by 34.0 days. Hence a is the correct option.