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A B C D E F G H I J
11/23/2018
RR Industry
Karen Johnson, CFO for Raucous Roasters (RR), a specialty coffee manufacturer, is rethinking her company’s working capital
policy in light of a recent scare she faced when RR’s corporate banker, citing a nationwide credit crunch, balked at renewing RR’s
line of credit. Had the line of credit not been renewed, RR would not have been able to make payroll, potentially forcing the
company out of business. Although the line of credit was ultimately renewed, the scare has forced Johnson to examine carefully
each component of RR’s working capital to make sure it is needed, with the goal of determining whether the line of credit can be
eliminated entirely. In addition to (possibly) freeing RR from the need for a line of credit, Johnson is well aware that reducing
working capital will improve free cash flow.
Chapter 16. Mini Case for Supply Chains and Working Capital Management
Johnson also knows that decisions about working capital cannot be made in a vacuum. For example, if inventories could be
lowered without adversely affecting operations, then less capital would be required, and free cash flow would increase. However,
lower raw materials inventories might lead to production slowdowns and higher costs, and lower finished goods inventories might
lead to stock-outs and loss of sales. So, before inventories are changed, it will be necessary to study operating as well as financial
effects. The situation is the same with regard to cash and receivables. Johnson has begun her investigation by collecting the ratios
shown below.
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A B C D E F G H I J
Inventory turnover 10.80 20.00
Fixed assets turnover 7.75 13.22
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COGS =0.90 ×$660,000
COGS =$594,000
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Inventory conversion period
Inventory conversion period
A B C D E F G H I J
Annual sales
$660,000
COGS/sales 90%
COGS =0.90 × Sales
=
Inventory / Daily COGS
Inventory conversion period
c. Calculate the firm’s cash conversion cycle given annual sales are $660,000 and cost of goods sold are 90% of sales. Assume a
365-day year.
First, determine the amount of inventory from the firm’s inventory turnover ratio. Then, calculate the inventory conversion period
from the data given in the problem.
a. Johnson plans to use the preceding ratios as the starting point for discussions with RR’s operating team. Based on the data,
does RR seem to be following a relaxed, moderate, or restricted current asset usage policy? See Ch16 Mini Case Show.
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g. Does RR face any risks if it tightens its credit policy? See Ch16 Mini Case Show.
changed by RR? See Ch16 Mini Case Show.
CCC =33.8 +45.6 –30
CCC =49.4
d. Is there any reason to think that RR may be holding too much inventory? See Ch16 Mini Case Show.
e. If RR reduces its inventory without adversely affecting sales, what effect should this have on free cash flow: (1) in the short run
and (2) in the long run? See Ch16 Mini Case Show.
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A B C D E F G H I J
Terms: free credit period = 10
days.
“Official” credit period = 30
days.
Company buys goods worth $200,000. That’s the cash price.
They must pay $2,020 more over the year if they forego the discount.
Think of the extra $2,020 as a financing cost similar to the interest on a loan.
Net daily purchases = $548
i. What is the impact of higher levels of accruals, such as accrued wages or accrued taxes? Is it likely that RR could
make changes to accruals? See Ch16 Mini Case Show.
j. Assume that RR purchases $200,000 (net of discounts) of materials on terms of 1/10, net 30, but that it can get away
with paying on the 40th day if it chooses not to take discounts. How much free trade credit can the company get from
its equipment supplier, how much costly trade credit can it get, and what is the percentage cost of the costly credit?
Should RR take discounts?
h. If the company reduces its DSO without seriously affecting sales, what effect would this have on its free cash flows: (1) in the
short run and (2) in the long run? See Ch16 Mini Case Show.
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A B C D E F G H I J
Total trade credit =
$21,918
Free trade credit =
$5,479
Costly trade credit =
$16,438
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A B C D E F G H I J
Nominal cost of costly trade credit:
r(nom) = $2,020
/$16,438
r(nom) = 12.29%
r(nom) =
12.29%
Effective Annual Rate
Periodic rate =
1% /99%
Periodic rate =
1.01%
m. RR tries to match the maturity of its assets and liabilities. Describe how RR could adopt either a more aggressive or a more
conservative financing policy. See Ch16 Mini Case Show.
k. Cash doesn’t earn interest, so why would a company have a positive target cash balance? See Ch16 Mini Case
l. What might RR do to reduce its target cash balance without harming operations? See Ch16 Mini Case Show.
n. What are the advantages and disadvantages of using short-term debt as a source of financing? See Ch16 Mini
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Cash Balance as presented in the Mini Case Nov Dec Jan Feb Mar Apr
Sales Forecast
( 1 ) Sales (gross) $71,218 $68,212 $65,213 $52,475 $42,909 $30,524
Collections
( 2) During month of sale
(month’s sales) x (0.98) x 0.2 12,781.75 10,285.10
( 3 ) During first month after sale
o. Would it be feasible for RR to finance with commercial paper? See Ch16 Mini Case Show.
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( 9 ) Rent 2,500.00 2,500.00
( 10 ) Taxes
( 11 ) Total payments $53,794.31 $44,443.55
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