P15–1 Cash conversion cycle Metal Supplies is concerned about its cash

management. On average, the day’s sales in inventory (duration of inventory on shelf) is

90 days. Accounts receivable are collected in 90 days, while accounts payable are paid
in 60 days. Metal Supplies has annual sales of $14 million, cost of goods sold of $9.5
million, and purchases of $5 million. (Note: Use a 365-day year.)

a. What is Metal Supplies’ operating cycle (OC)?

ANSWER:
Operating Cycle = Days Sales in Inventory + Days Sales Outstanding
= 90 days + 90 days
= 180 days

b. What is Metal Supplies’ cash conversion cycle?

ANSWER:
Cash Conversion Cycle = Operating Cycle – Days Payable Outstanding
= 180 days – 60 days
= 120 days

c. What is the amount of resources needed to support Metal Supplies’ cash

conversion cycle?

ANSWER:
Inventory = Cost of Goods Sold / 365 x Days Sales in Inventory
= $ 9,500,000 / 365 x 90
= $ 2,342,465.75

Accounts Receivable = Sales / 365 x Days Sales Outstanding

= $ 14,000,000 / 365 x 90
= $ 3,452,054.80

Accounts Payable = Cost of Goods Sold / 365 x Days Payable Outstanding

= $ 9,500,000 / 365 x 60
= $ 1,561,643.84

Resources Needed = Inventory + Accounts Receivable – Accounts Payable

= $ 2,342,465.75 + $ 3,452,054.80 - $ 1,561,643.84
= $ 4,232,876.71

d. What suggestions would you give Metal Supplies to reduce its cash conversion
cycle?

ANSWER:
 To reduce conversion cycle it should decrease in Decrease in Days Sales
Outstanding and Increase in days Payable Outstanding

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 P15–3 Multiple changes in cash conversion cycle Garrett Industries turns over its
inventory six times each year; it has an average collection period of 45 days and an
average payment period of 30 days. The firm’s annual sales are $3 million. Assume that
there is no difference in the investment per dollar of sales in inventory, receivables, and
payables, and assume a 365-day year.

a. Calculate the firm’s cash conversion cycle, its daily cash operating expenditure,
and the amount of resources needed to support its cash conversion cycle.

Inventory Turnover Ratio = 365 / Inventory turnover period

= 365 / 6
= 60.83

Operating Cycle = Inventory Turnover Ratio + Receivable period

= 60.83 + 45
= 105.83

Cash Conversion Cycle = Inventory days + Receivable days – Payable days

= 60.83 + 45 – 30
= 75.83

Daily Financing = $ 3,000,000 / 365

= $ 8,219.18

= $ 8,219.18 x 60.83
= $ 499,972.60 499,972.72

= $ 8,219.18 x 45
= 369,863.1

= $ 8,219.18 x 30
= $ 246,575.40

b. Find the firm’s cash conversion cycle and resource investment requirement if it
makes the following changes simultaneously.
(1) Shortens the average age of inventory by 5 days.
(2) Speeds the collection of accounts receivable by an average of 10 days.
(3) Extends the average payment period by 10 days.

c. If the firm pays 13% for its resource investment, by how much, if anything,
could it increase its annual profit as a result of the changes in part b?

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 d. If the annual cost of achieving the profit in part c is $35,000, what action would
you recommend to the firm? Why?

P15–5 EOQ analysis Enviro Exhaust Company purchases 1,200,000 units per year of
a component with a purchase price of $50. The fixed cost is $15 per order, and the
carrying cost is 30% of the purchase price.

a. Calculate the economic order quantity (EOQ) based on the data given.
b. Calculate the EOQ if the order cost is zero. What is the implication to the firm if
there is a decrease in the order cost?

P15–6 EOQ, reorder point, and safety stock Outdoor Living Manufacturers uses
1,000 units of a product per year. The fixed cost is $28 per order, while the carrying cost
is $5 per unit per year. The lead time is 5 days and, therefore, the firm keeps 7 days’
usage in inventory as safety stock. (Note: Use a 365-day year where required.)

a. Calculate the economic order quantity (EOQ) and the average inventory.
b. How many orders will Outdoor Living Manufacturers place during one year?
c. When should Outdoor Living Manufacturers place its orders?
d. Suppose Outdoor Living Manufacturers does not keep safety stock. Explain the
changes, if any, that will occur in (1) order cost, (2) carrying cost, (3) total inventory cost,
(4) reorder point, and (5) EOQ.

P15–8 Accounts receivable changes without bad debts Clear Glass Company sells
glass containers. It reported total sales of $1,580,000, with 60% of the sales on credit. It
takes 60 days to collect accounts receivable. The selling price is $20 per container
while the variable cost is $15 per container. The board is currently investigating a
change in the collection of accounts receivable that is expected to result in a 20%
increase in credit sales and a 10% increase in the average collection period. No change
in bad debt is expected. The firm’s opportunity cost on its investment in accounts
receivable is 12%. (Note: Use a 365-day year.)
a. Calculate the additional profit contribution from sales if the change in collecting
accounts receivable is implemented.
b. Calculate the marginal investment in accounts receivable that will result from the
change.
c. Calculate the cost of the marginal investment in accounts receivable.
d. Would you recommend the firm implement the proposed change?

P15–9 Accounts receivable changes with bad debts Clear Glass Company sells
glass containers. It reported total sales of $1,580,000, with 60% of the sales on credit. It
takes 60 days to collect accounts receivable. The selling price is $20 per container while
the variable cost is $15 per container. The board is currently investigating a change in
the collection of accounts receivable that is expected to result in a 20% increase in
credit sales and a 10% increase in the average collection period. Bad debts will also
increase, from 2% to 4% of sales. The firm’s opportunity cost on its investment in
accounts receivable is 12%. (Note: Use a 365-day year.)

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 a. Calculate bad debts in dollars for the current and proposed plans.
b. Calculate the cost of the marginal bad debts to Clear Glass Company.
c. Would you recommend the proposed plan? Explain.
d. Under what circumstances would the decision to implement the proposed plan
change?

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