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? Do not round your intermediate calculations.

A) $2,134
B) $1,888
C) $1,454
D) $1,813
E) $1,775

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? Do not round your intermediate calculations.

A) $2,134 
B) $1,888 
C) $1,454 
D) $1,813 
E) $1,775

Quizplus · Accepted Answer

First, we need to calculate the current values of net working capital and cash conversion cycle:

Net working capital = Current assets - Current liabilities
= $29 + $60 - $45 - $48
= -$4 million

Cash conversion cycle = Days inventory outstanding + Days sales outstanding - Days payables outstanding
= (365/$112) + (365/$208) - (365/$156)
= 3.26 days

Next, we need to calculate the benchmark values for net working capital and cash conversion cycle by using the formulas given in the question:

Benchmark net working capital = 15% of sales
= 0.15 x $990
= $148.5 million

Benchmark cash conversion cycle = 60 days

We can now calculate the required changes in net working capital and cash conversion cycle:

Change in net working capital = Benchmark net working capital - Current net working capital
= $148.5 - (-$4)
= $152.5 million

Change in cash conversion cycle = Benchmark cash conversion cycle - Current cash conversion cycle
= 60 - 3.26
= 56.74 days

The cost of financing the change in net working capital is:

Cost = Interest rate x Amount x Time
= 0.08 x $152.5 million x (56.74/365)
= $1.888 million

Finally, we can calculate the increase in pre-tax income:

Increase in pre-tax income = Change in cash flow / (1 - Tax rate)
= ($1.888 million / (1 - 0.35)
= $2.898 million

Therefore, the firm's pre-tax income would have increased by $1.888 million if the changes had been made.