Strategies to Improve Cash Conversion Cycle and Credit Policy Evaluation

Q1. Costco carries an average inventory of $1500000. Its annual sales are $8million and its gross profit margin is 25%. The receivable conversion period is twice as long as its inventory conversion period. Costco trade terms with its suppliers is net 120 and it always pays on time. Costco’s new CFO wants to improve the cash conversion cycle by 50 days. Based on a 365-day year. His first strategy is to reduce the amount of inventory to $1100000, but he thinks this move will reduce the annual sales by 20%. The gross profit margin will remain the same as before. His second strategy is to negotiate longer credit term with the suppliers, and he expects this move will increase his account payable balance by 15%. By how much must the firm also reduce its accounts receivable level to meet its goal of a 50 day reduction in the cash conversion cycle

Q2: Dyson is considering changing the credit term for its customers and also enforcing its credit policy more strongly. Dyson’s annul sales is $7million and the current credit term is 1/20, net 45.Right now, 10% of the customer paid by cash 30% of the customer paid in Day 20, 55% of the customer paid in Day 45 and still take the discount( which they shouldn’t ), and 5% of the customer paid late in Day55. Dyson wants to change the credit term to 2/10, net 35. It believes the stricter enforcement of the credit policy will result in a 5% decline in annual sales. Under the new policy, 10% of the customer will still pay by cash, 50% of the customer will pay in Day 10, and 40% of the customer will pay in Day 35 and Dyson will ensure these customers don’t get the discount. As a result of tying to enforce the new policy. Dyson would also have to add one additional staff to its existing AR department and the annual salary of this staff is $4000. Bad debt is currently sitting at 3% of credit sales and , Dyson estimates that bad debt would reduce to 1.5% of credit sales under the new policy. Dyson’s profit margin is 30% and it has a line of credit with the bank charging an interest rate of 8%. Should Dyson change its credit policy?

Q3: Which items does a firm’s credit policy consist of?

· Cash discounts, credit standards, receivables monitoring, collection policy

· Credit period, cash discounts, credit standards, receivable monitoring

· Credit period, cash discounts, credit standards, collection policy

· Credit period, cash discounts, receivables monitoring collection policy

Q4: Which of the following will likely to shorten the length of the cash conversion cycle?

a. Start paying its bills sooner, which reduces its average accounts payable without reducing its sales

b. Issue more bonds/stock to get more cash

c. Increase its average inventory without increasing its sales

d. Reduce its DSO.

Q5: Canadian Tire’s stock price at the end of last year was$18 and from the balance sheet, you calculated that its book value per share was $5. What was its market/book ratio?

a. 3.6

b. 1.4

c. 2.78

d. 3.4

Q6: Sporting Life expects to have sales of $30000 in April, $35000 in May, and $40000 in June, 20% company’s sales are paid by cash and the rest are paid on credit. Of the credit sales, 50% of the credit sales is paid in the month following the sale and the other 50% are paid 2 months following the sale, what are the cash receipts for the firm in June?

a. $32300

b. $29151

c. $34000

d. $30685

Q7: Canadian Tire’s stock price at the end of last year was $1800, and from the balance sheet, you calculated that the book value per share was $5. What was its  market/book ratio?

a. 3.6

b. 1.4

c. 2.78

d. 3.4