Soenen Inc. had the following data for last year (in millions). The new CFO beli

Question

Soenen Inc. had the following data for last year (in millions). The new CFO believes that the company could improve its working capital management sufficiently to bring its net working capital and cash conversion cycle up to the benchmark companies' level without affecting either sales or the costs of goods sold. Soenen finances its net working capital with a bank loan at an 8% annual interest rate, and it uses a 365-day year. If these changes had been made, by how much would the firm's pre-tax income have increased?

Original Data Related CCC Benchmarks' CCC Sales $99,000 Cost of goods sold $80,000 Inventory (ICP) $20,000 91.25 38.00 Receivables (DSO) $16,000 58.99 20.00 Payables (PDP) $5,000 22.81 30.00 127.43 28.00

Explanation / Answer

Current Working Capital = Current Assets + Current Liability

= (Inventory + Account Receivables) - Account payables

= ($20,000 + $16,000) - $5,000

= $36,000 - $5,000

= $31,000

Current Working capital is $31,000.

Now, Benchmark Working capital

Inventory days = 38.

Benchmark Inventory = ($80,000 / 365) × 38

= $219.18 × 38

= $8,329.

Benchmark Receivables = ($100,000 / 365) × 20

= $273.97 × 20

= $5,479

Benchmark Payables = ($80,000 / 365) × 30

= $219.18 × 30

= $6,575

Benchmark Working capital = ($8,329 + $5,479) - $6,575

= $13,808 - $6,575

= $7,233.

Benchmark working capital is $7,233.

Release of short term cash = $31,000 - $7,233

= $23,767.

Release of shhort term cash is $23,767.

Interest on short term debt = 8%

Increase in income = $23,767 × 8%

= $1,906.

Increase in income is 1,906.

Option (E) is correct answer.

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