Question

Williams & Sons last year reported sales of $49 million, cost of goods sold (COGS) of $40 and an inventory turnover ratio of 4. The company is now adopting a new inventory system. If the new system is able to reduce the firm's inventory level and increase the firm's inventory turnover ratio to 5 while maintaining the same level of sales and COGS, how much cash will be freed up? Do not round intermediate calculations. Round your answer to the nearest dollar.

Answer 1

Answer : Amount of Cash Freed up : $2,000,000

Calculations

Inventory Turnover Ratio = Cost of Goods Sold / Inventory

==> Inventory = Cost of Goods sold / Inventory Turnover Ratio

Amount of Inventory under existing system = 40,000,000 / 4

= 10,000,000

Amount of Inventory under new system = 40,000,000 / 5

= 8,000,000

Amount of Cash Freed up = Amount of Inventory under existing system - Amount of Inventory under new system

  = 10,000,000 - 8,000,000

= $2,000,000