Arabica, Inc. has found that turns its inventory over 10 times per year, it take

Question

Arabica, Inc. has found that turns its inventory over 10 times per year, it takes an average of 25 days to collect on its accounts receivables, and that on average it pays its suppliers in 40 days. Given this information:

Determine Arabica%u2019s operating cycle and cash conversion cycle.

Annually, Arabica purchases $4,000,000 in inventory and financing costs the firm 12%. The firm is considering investing in inventory management software that will cost the firm $10,000 per year. However, they are certain that using the new software will allow them increase inventoryturnover to 12 times per year. Given this explain whether or not it makes sense for the firm to spend the $10,000 annually on the inventory management software.

Explanation / Answer

Inventory Conversion period = 365/10 = 36.5 days

Cash Conversion cycle = 36.5 + 25 - 40 = 21.5 days

Operaating Cycle = 21.5 days

so after purchasing new software

Inventory connversion period = 365/12 = 30.4167

Csh Conversion cycle = 15.41667 days ;

so it reduced by = 21.5 - 15.4167 = 6.0833 days

per day interest = 12/365 %

for 6.0833 days interest = 4,000,000 / 365 * (1+12/36500)^6.0833 = 15,695.909

and we paying $10,000 so it makes sense for firm to spend money as it will save interest

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