Question

Pasha Corporation produces motorcycle batteries. Pasha turns out 1,400 batteries a day at a cost of $7 per battery for materials and labor. It takes the firm 22 days to convert raw materials into a battery. Pasha allows its customers 40 days in which to pay for the batteries, and the firm generally pays its suppliers in 30 days.

a. What is the length of Pasha’s cash conversion cycle?
b. At a steady state in which Pasha produces 1,400 batteries a day, what amount of working capital must it finance?
c. By what amount could Pasha reduce its working capital financing needs if it was able to stretch its payables deferral period to 33 days?
d. Pasha’s management is trying to analyze the effect of a proposed new production process on its working capital investment. The new production process would allow Pasha to decrease its inventory conversion period to 17 days and to increase its daily production to 2,400 batteries. However, the new process would cause the cost of materials and labor to increase to $12. Assuming the change does not affect the average collection period (40 days) or the payables deferral period (30 days), what will be the length of its cash conversion cycle and its working capital financing requirement if the new production process is implemented?

Answer 1

Ans A) Pasha's Cash conversation cycle =  DIO+DSO−DPO

where:

DIO=Days of inventory outstanding(also known as days sales of inventory)

DSO=Days sales outstanding

DPO=Days payables outstanding​

Cash Conversation cycle = 40+22-30

=32

Ans B)Working Capital Pasha requires = $7 per Battery cost * 1400 Battery = $9800 per day *32 cash cycle

= $ 313600

Ans C) If Payment Period stretch to 33 Days,

Cash cycle = 40+22-33

=29

Working Capital= 9800*29 = $284200

Reduce in W.C. = 313600-284200

= $ 29400

Ans D)If new Process Implemented

New invetory day reduced 17 day so =22-17 = 5

New Cash Conversation Cycle = 40+5-30

=15

New W.C Requirement = $ 12 (Battery cost) *2400(Battery Production) * Cycle

= 28800 per day * 15

= $ 432000