Ferson Inc.has annual sales of $36,500,000,or $100,000 a day on a 365-day basis.On average,the company has $12,000,000 in inventory and $8,000,000 in accounts receivable.The firm is looking for ways to shorten its cash conversion cycle,which is calculated on a 365-day basis.Its CFO has proposed new policies that would result in a 20% reduction in both average inventories and accounts receivables.She also anticipates that these policies would reduce sales by 10%,while accounts payable would remain unchanged.What effect would these policies have on the company's cash conversion cycle? Round to the nearest whole day.

Question

Quizplus · Accepted Answer

First, we need to calculate the current cash conversion cycle:
Cash Conversion Cycle = DIO + DSO - DPO
DIO = (Avg. Inventory / COGS) * 365 = (12,000,000 / (36,500,000 * (1 - 0.4))) * 365 = 142.47 days
DSO = (Avg. AR / Sales) * 365 = (8,000,000 / 36,500,000) * 365 = 79.45 days
DPO = (COGS / Avg. AP) * 365 = (26,590,000 / (36,500,000 * (1 - 0.4))) * 365 = 124.03 days
Cash Conversion Cycle = 142.47 + 79.45 - 124.03 = 97.89 days

Then, we need to calculate the changes in DIO and DSO:
New DIO = 0.8 * 142.47 = 113.98 days
New DSO = 0.8 * 79.45 = 63.56 days

The change in sales is 10%, so the new sales would be $32,850,000:
New DPO = 124.03 days (remains unchanged)
New Cash Conversion Cycle = 113.98 + 63.56 - 124.03 = 53.51 days

Therefore, the proposed policies would decrease the cash conversion cycle by 97.89 - 53.51 = 44.38 days, which rounds to -22 days when rounded to the nearest whole day. So the answer is B.