fm22 16 - This suggests that it simply has excessive...

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b. How can one distinguish between a relaxed but rational working capital policy and a situation in which a firm simply has a lot of current assets because it is inefficient? Does SKI’s working capital policy seem appropriate? Answer: SKI may choose to hold large amounts of inventory to avoid the costs of “running short,” and to cater to customers who expect to receive their equipment in a short period of time. SKI may also choose to hold high amounts of receivables to maintain good relationships with its customers. However, if SKI is holding large stocks of inventory and receivables to better serve customers, it should be able to offset the costs of carrying that working capital with high prices or higher sales, and its ROE should be no lower than that of firms with other working capital policies. It is clear from the data in table 22-1 that SKI is not as profitable as the average firm in its industry.
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Unformatted text preview: This suggests that it simply has excessive working capital, and that it should take steps to reduce its working capital. c. Now, calculate the firm’s cash conversion cycle. Assume a 365 day year. Answer: A firm’s cash conversion cycle is calculated as: . cycle conversion Cash period deferral Payables period collection s Receivable period conversion Inventory = − + SKI’s inventory turnover is given as 4.82 so we can calculate its inventory conversion period as: 82 . 4 365 turnover Inventory 365 = = 75.73 ≈ 76 DAYS. SKI’s receivables collection period is equal to its DSO. Its DSO is given as 45.63 days, or approximately 46 days. We are given that its payables deferral period is 30 days, so now we have all the individual components to calculate SKI’s cash conversion cycle. 76 days + 46 days – 30 days = 92 days. Thus, SKI’s cash conversion cycle is approximately 91 days. Mini Case: 22 - 16...
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This note was uploaded on 07/13/2011 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.

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