Margetis Inc. carries an average inventory of $750,000. Its annualsale

QUESTION

Margetis Inc. carries an average inventory of $750,000. Its annualsales are $10 million, its cost of goods sold is 75% of annual sales,and its average collection period is twice as long as its inventoryconversion period. The firm buys on terms of net 30 days, and it payson time. Its new CFO wants to
According to the given information,Cost of gooods sold = 75% ($10,000,000) = $7,500,000Inventory turnover ratio = Cost of goods sold / Average inventory = $7,500,000 / $750,000 = 10 timesDays sales in inventory = 365 / Inventory turnover ratio = 365/ 10 = 36.5 daysBut the average collection period is twice of the inventory conversion period.Average collection period = 2 (36.5 days) = 73 daysFrom Average collection period = (Accounts receivables * 365) / Credit sales 73days = (AR * 365) / $10,000,000 $730,000,000 = AR * 365 AR = $2,000,000Average collection period is same as DAys sales outstanding.Since the payables are paid in time, the days payable outstanding is 30 daysCash conversion cycle = DSO DIO DPOWhere DSO = Days sales outstanding DIO = Days inventory outstanding DPO = Days payable outstandingCAsh conversion cyle = 73 days 36.5 days 30days = 79.5 daysIf the CCC is reduced by 10 days, then the average inventory comes to

47,260 keeping sales constant. Therefore, there exists a change in the DAys inventory outstanding.DAys inventory outstanding = (365 / Inventory turnover) = 365 / (Cost of goods sold / Average inventory) = 365 / ($7,500,000 / $647,260) = 365 / 11.59 = 31.5 daysThe DIO has decreased by 5 days and the DSO has to be reduced by another 5 days to reduce the CCC by 10 days. DSO = (Accounts receivables * 365) / Credit sales 68 = (AR * 365) / $10,000,000 $680,000,000 = AR * 365 AR = $680,000,000 / 365 = $1,863,014Therefore, the accounts receivable should be reduced by $2,000,000 $1,863,014 = $136,986The correc option is c) $136,986

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