Week 7 Problem Set
Answer the following questions and solve the following problems in the space provided. When you are done, save the file in the format flastname_Week_7_Problem_Set.docx (where flastname is your first initial and your last name), and submit it to the appropriate Dropbox.
Chapter 26 (page 903):
1. Answer the following questions:
a. What is the difference between a firm’s cash cycle and its operating cycle?
An operating cycle is the average time period between the acquisition of inventory and the receipt of cash from the inventory's sale. A short operating cycle means a more prompt return on investment for the firm's inventory. The cash conversion cycle is the number of days required for a company to convert resources to cash flows. This measure calculates the time period during which each input dollar is committed to production and sales processes before it is converted to cash through the accounts receivable process. The cash conversion process gives insight into the financial stability of a company because it reflects the time period during which assets are committed to business processes and therefore are not available to invest to achieve even greater returns. As a result, the shorter the cash conversion cycle, the better.
b. How will a firm’s cash cycle be affected if a firm increases its inventory, all else being equal?
Excessive inventory uses cash. Acquisition costs, storage, order costs, carrying costs etc. Benefits of holding inventory: avoid stock-outs, seasonality factors. WCN = Inventory + Accounts receivable – Accounts Payable. The cash cycle will increase.
c. How will a firm’s cash cycle be affected if a firm begins to take the discounts offered by its suppliers, all else being equal?
4. The Greek Connection had sales of $32 million in 2012, and a cost of goods sold of $20 million. A simplified balance sheet for the firm appears below:
THE GREEK CONNECTION
As of December 31, 2012 (in $ thousand)
Liabilities and Equity
$ 2,000 3,950 1,300
$ 1,500 1,000 1,220
Total current assets $ 7,250 Total current liabilities
$ 3,720 3,000
Net plant, property, and equipment $ 8,500
$ 6,720 9,030
Total liabilities and equity
a. Calculate The Greek Connection’s net working capital in 2012.
Net working capital = current assets - its current liabilities
=$7,250 - $3,720 = $3,530
b. Calculate the cash conversion cycle of The Greek Connection in 2012.
The cash conversion cycle (CCC) is defined as
CCC = Accounts Receivable Days + Inventory Days − Accounts Payable Days
Accounts Receivable Days = 3,950,000/(32,000,000/365) = 45.054687
Inventory Days = 1,300,000/(20,000,000/365) = 23.725
Accounts Payable Days = 1,500,000/(20,000,000/365) = 27.375
CCC = 45.054687 + 23.725 – 27.375 = 41.404687 days
c. The industry average accounts