Question 6: (12 marks) Lee Man Adik-Beradik Furniture Enterprise has S550,000 in
ID: 2807686 • Letter: Q
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Question 6: (12 marks) Lee Man Adik-Beradik Furniture Enterprise has S550,000 in inventory and $256,000 in accounts receivable. Its average daily sales are S10,000. The company's payables deferral period (accounts payable divided by daily purchases) is 30 days. Purchases represent about 80% of (12 marks) sales. [Use 365 days per year] What is the length of the company's cash conversion cycle? (4 marks) If forecasted sales turnover for the coming year represent a 20% increase over the current year's turnover, what would be the company's expected working capital (2 marks) requirement? Suppose the company is considering a plan that would stretch its accounts payable by 10 days. What would the company's accounts payable balance be as compared with (3 marks) the current balance? How would this plan affect the expected working capital requirement of the company? Explain. [Hint: Relate with the result you obtained in part (c) above] (3 marks)Explanation / Answer
a. Cash Conversion Cycle : 64.35 days.
Cash coversion cycle =Inventory conversion period + Days' sales outstanding - Payables deferral period.
Inventory Conversion Period =[ 365 / ( 365 x 10,000) x 80 %] x 550,000 = 68.75 days.
Days Sales Outstanding = [ 365 / ( 365 x 10,000) ] x 256,000 = 25.60 days.
Cash Conversion Cycle = 68.75 days + 25.60 days - 30 days = 64.35 days.
b. Expected Working Capital Requirement:: $ 679,200
Inventory = $12,000 x 80 % x 68.75 days = $ 660,000
Receivables = $ 12,000 x 25.60 = $ 307,200
Payables = 12,000 x 80 % x 30 = $ 288,000
Working Capital Required = $ 660,000 + $ 307,200 - $ 288,000 = $ 679,000
c. New Accounts Payables Balance = $ 320,000
Current Accounts Payable Balance = $ 240,000
Let the current accounts payable balance be A.[ 365 / ( 10,000 x 80% x 365) ] x A = 30
A : $ 240,000
If the payables deferral period = ( 30 + 10) = 40 days
New Accounts Payable = [ 365 / ( 10,000 x 80 % x 365) ] x A = 40
A = $ 320,000.
d. New Working Capital Requirement : $ 486,000
New Working Capital Requirement = $ 10,000 x 80 % x 68.75 days + $ 10,000 x 25.60 - $ 10,000 x 80% x 40 = $ 550,000 + $ 256,000 - $ 320,000 = $ 486,000
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