FIN 370 Version 8 Week 3 DQ

You have to select between two projects, Project A has a 12% required rate of return and the company invested $30000 for the first period. 

 Project B in unrelated and has a 18% required rate of return, Initial investment is $135,000

 Using net present value, which project should be selected and why.

Find out how your company determines how they make capital investment decisions. What criteria do they use? How do they determine incremental cash flows?

What is the four step procedure for estimating project cash flows for future periods?

Use the cash conversion cycle to measure the efficiency with which a firm manages its working capital.

Cash Conversion Cycle

Cash conversion cycle is the time it takes a company to convert its resource inputs into cash. It measures how effectively a company is managing its working capital.

Formula

Where DSO is days sales outstanding, DIO is days inventory outstanding and DPO is days payables outstanding.

It can also be calculated if we already know the operating cycle:

Analysis

Shorter the cash conversion cycle the better the company is off because it has to lock up cash for a relatively smaller period of time.

Example

Company K has receivables turnover ratio of 12, inventory turnover ratio of 10 and payable turnover ratio of 8. Find the cash conversion cycle.

Solution

We first need to convert the turnover measures to number of days measures.

Days sales outstanding = 365/receivables turnover ratio = 365/12 = 30.42 days
Days inventory outstanding = 365/inventory turnover ratio = 365/10 = 36.4 days
Days payables outstanding = 365/payables turnover ratio = 365/8 = 45.63 days
Cash conversion cycle = DSO + DIO − DPO = 30.42 + 36.4 − 45.63 = 21.19

If the industry average cash conversion ratio is 25 the company is better off than other companies.

Ok, now you try

Company A has receivables turnover ratio of 18, inventory ratio of 12 and a payable turnover ratio of 32.  Find the cash conversion cycle

Define operating and cash flow cycles.  How are they different?