IM No.

: IM-FM1-1STSEM-2020-2021
Republic of the Philippines NUEVA
VIZCAYA STATE UNIVERSITY
Bayombong, Nueva Vizcaya
INSTRUCTIONAL MODULE

VI. LEARNING ACTIVITIES

VII. ASSIGNMENT

CASH CONVERSION CYCLE Parramore Corp has $12 million of sales, $3 million of inventories,
$3.25 million of receivables, and $1.25 million of payables. Its cost of goods sold is 75% of sales,
and it finances working capital with bank loans at an 8% rate. What is Parramore’s cash
conversion cycle (CCC)? If Parramore could lower its inventories and receivables by 10% each
and increase its payables by 10%, all without affecting sales or cost of goods sold, what would be
the new CCC, how much cash would be freed up, and how would that affect pretax profits?
 Cash conversion circle = 122+99 – 51 = 170 days

Revised Cash conversion circle = 110+89 – 56 = 143 days

The amount of cash to be freed up = (0.1 x $3m) + (0.1 x $3.25) + (0.11 x $1.25) = $762,500

Pretax profits will be increased because lower inventory level leads to lower cost of sales and
higher gross profit which means higher net profits

RECEIVABLES INVESTMENT Leyton Lumber Company has sales of $12 million per year, all on
credit terms calling for payment within 30 days, and its accounts receivable are $1.5 million. What
is Leyton’s DSO, what would it be if all customers paid on time, and how much capital would be
released if Leyton could take action that led to on-time payments?

COST OF TRADE CREDIT AND BANK LOAN Lancaster Lumber buys $8 million of materials
(net of discounts) on terms of 3/5, net 55, and it currently pays on the 5th day and takes
discounts. Lancaster plans to expand, which will require additional financing. If Lancaster decides
to forgo discounts, how much additional credit could it obtain, and what would be the nominal and
effective cost of that credit? If the company could get the funds from a bank at a rate of 9%,
interest paid monthly, based on a 365-day year, what would be the effective cost of the bank
loan? Should Lancaster use bank debt or additional trade credit? Explain.

WORKING CAPITAL INVESTMENT 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
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only and not for commercial distribution
,”NVSU-FR-ICD-05-00 (081220)
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 IM No.: IM-FM1-1STSEM-2020-2021
Republic of the Philippines NUEVA
VIZCAYA STATE UNIVERSITY
Bayombong, Nueva Vizcaya
INSTRUCTIONAL MODULE

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?

CASH BUDGETING Helen Bowers, owner of Helen’s Fashion Designs, is planning to request a
line of credit from her bank. She has estimated the following sales forecasts for the firm for parts
of 2018 and 2019:

Estimates regarding payments obtained from the credit department are as follows: collected
within the month of sale, 10%; collected the month following the sale, 75%; collected the second
month following the sale, 15%. Payments for labor and raw materials are made the month after
these services were provided. Here are the estimated costs of labor plus raw materials:

General and administrative salaries are approximately $27,000 a month. Lease payments under
long-term leases are $9,000 a month. Depreciation charges are $36,000 a month. Miscellaneous
expenses are $2,700 a month. Income tax payments of $63,000 are due in September and
December. A progress payment of $180,000 on a new design studio must be paid in October.
Cash on hand on July 1 will be $132,000, and a minimum cash balance of $90,000 should be
maintained throughout the cash budget period.

a. Prepare a monthly cash budget for the last 6 months of 2018.

b. Prepare monthly estimates of the required financing or excess funds—that is, the amount of
money Bowers will need to borrow or will have available to invest.

c. Now suppose receipts from sales come in uniformly during the month (that is, cash receipts
come in at the rate of 1/30 each day), but all outflows must be paid on the 5th. Will this affect
the cash budget? That is, will the cash budget you prepared be valid under these
assumptions? If not, what could be done to make a valid estimate of the peak financing

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only and not for commercial distribution
,”NVSU-FR-ICD-05-00 (081220)
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 IM No.: IM-FM1-1STSEM-2020-2021
Republic of the Philippines NUEVA
VIZCAYA STATE UNIVERSITY
Bayombong, Nueva Vizcaya
INSTRUCTIONAL MODULE

requirements? No calculations are required, although if you prefer, you can use calculations
to illustrate the effects.

d. Bowers’ sales are seasonal, and her company produces on a seasonal basis, just ahead of
sales. Without making any calculations, discuss how the company’s current and debt ratios
would vary during the year if all financial requirements were met with short-term bank loans.
Could changes in these ratios affect the firm’s ability to obtain bank credit? Explain.
Answer:

A.

B.

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only and not for commercial distribution
,”NVSU-FR-ICD-05-00 (081220)
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 IM No.: IM-FM1-1STSEM-2020-2021
Republic of the Philippines NUEVA
VIZCAYA STATE UNIVERSITY
Bayombong, Nueva Vizcaya
INSTRUCTIONAL MODULE

C.
The assumption made with regard to the above prepared budget is that all inflow & outflows are occurring
uniformly throughout the month. However, in this case, there will be a cash flow mismatch since payments
need to be paid on 5th of the month while inflows will come uniformly during the month. For this reason, there
is need for the company to take the short- term finance facility from the bank. The company will have to take
a finance of total outflow amount in the first month i.e. 5 days receipts of cash in that month. This amount can
then be repaid by the end of the month. In this way the estimate of cash budget can be prepared.
D.
The company will continue to produce goods during the off season. Secondly, the short-term bank loan will
increase the company’s debt ratio. Thirdly, because of increase in production there will be an increase in
stock. This will in turn result in the increase in current assets thereby increasing the current ratio of the
company.
Because of seasonal sales, there will be a mismatch in the company’s working capital. On overall the credit
position of the company will remain the same. However, it will only be able to obtain short term loans but not
long term ones.

“In accordance with Section 185, Fair Use of Copyrighted Work of Republic Act 8293, the copyrighted works included in this material may be reproduced for educational purposes
only and not for commercial distribution
,”NVSU-FR-ICD-05-00 (081220)
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