Practice Question 1: Dhaulagiri Electronics Inc. is concerned about managing cash efficiently. On the average, inventories have an average age of 75 days, and accounts receivable are collected in 40 days. Accounts payable are paid approximately after 35 days they arise. The firm spends Rs 50 million operating cycle investments each year, at a constant rate. Assuming a 360-day year: a. Calculate the firm's operating cycle and cash conversion cycle.
b. Calculate the amount of negotiated financing required to support the firm's cash conversion cycle. [Shanker Dev Campus, mid term]
Solution
Inventory conversion period (ICP) = 15 days
Receivable conversion period (RCP) = 70 days
payable deferral period (PDP) = 5 days
days in a year = 360 days
Annual operating cycle investment = 50 million = 5,00,00,000
a) Firm's operating cycle = OC = ICP + RCP
= 15 + 70
= 115 days
Cash conversion cycle (CCC) = operating cycle - PDP
= 115 days - 5 days
= 80 days
Therefore the operating cycle and cash conversion
cycle is 115 days and 80 days respectively
b) The amount of negotiable financing required to support the firm cash conversion cycle
Amount of negotiated finance = (annual operating cycle investment / days in a year ) x CCC
= (5,00,00,000/360) x 80
= 1,11,11,111.11
The amount of negotiated financing required to support the firm is Rs 1,11,11,111.11.
Practice Question 2: Agro-Nepal Company Limited is a producer of cornflakes. Agro-Nepal produces 1,500 (200 grams) packets of cornflakes a day. Material and labor costs are Rs. 15 per packet. It takes 22 days to convert raw materials into finished goods. Agro-Nepal allows its customers 40 days to pay for the cornflakes and the firm generally pays its suppliers in 30 days.
a. What is the length of Agro-Nepal's cash conversion cycle?
b. If Agro Nepal always produces and sells 1,500 packets of cornflakes a day, what amount of working capital must it finance?
c. By what amount could Agro-Nepal reduce its working capital financing needs if it was able to stretch its payable deferred period to 35 days?
d. Agro Nepal's management is trying to analyze the effect of replacing equipment used in its production process on the working capital. The replacement by new equipment would allow Agro-Nepal to decrease its inventory conversion period to 20 days and increase its daily production to 1,800 packets of cornflakes. However, the new equipment would cause to cost of materials and labor to increase to Rs. 17. Assuming the change does not affect the receivables collection period (40 days) or the payables deferred period (30 days), what will be the length of the cash conversion cycle and the working capital requirement if the new equipment is installed?
Given:
Finished product or batteries = 1,500 batteries
Material and labor cost per battery = Rs. 6
Time to convert raw material into battery or inventory conversion period (ICP) = 22 days
Customers pay for the batteries or receivables collection period (RCP) = 40 days
Corporation pays its suppliers or payables deferred period (PDP) = 30 days
a. Cash conversion cycle =?
CCC ICP + RCP-PDP = 22+40-30 = 32 days.
b. The working capital =?
Working capital (per day)
= No. of batteries produced per day x working capital requirement per day
= 1,500 x Rs. 15
= Rs. 22,500
Total working capital requirement
= Length of cash conversion cycle x working capital requirement per day
= 32 x Rs. 22,500 = Rs. 720,000
Therefore Verbrugge must finance in working capital Rs. 720,000.
c. The reduction amount
Cash conversion cycle (CCC) = ICP + RCP-PDP=22+40-35 = 27 days
Total working capital requirement
= Length of cash conversion cycle x working capital requirement per day
= 27 x Rs. 22,500
= Rs. 607,500
Reduction in working capital requirement Rs. 720,000-Rs. 607,500 Rs. 112,500
d. The new production process or not
Cash conversion cycle = ICP + RCP - PDP=20+40-30 = 30 days
Working capital requirement per day
= No. of batteries produced per day x working capital requirement per day
= 1,800 x Rs. 17
= Rs. 30,600
Total working capital requirement
= Length of cash conversion cycle x working capital requirement per day
= 30 x Rs. 30,600
= Rs. 978,000
Practice Question no. 3
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