Master Construction has credit sales of $950,000 and a gross profit margin of 29 percent. The company’s inventory conversion period is 113 days, its receivable turnover is 5, and its payable deferral period is 25 days. The company has fixed assets of $430,000 and holds negligible amounts of cash and marketable securities. Its cost of capital on both short and long-term debt is 10 percent, and 60 percent of assets are funded by equity. Fixed operating expenses amount to $60,000 per annum. The company’s tax rate is 40 percent.

 

Sales and fixed operating expenses are anticipated to remain constant in the forthcoming financial year as the business is facing tougher industry conditions.  

 

Two alternatives regarding the projected current asset level for the next financial year are available to the firm: (1) a tight working capital policy requiring current assets of 45 percent of projected sales, and (2) a relaxed working capital policy requiring current assets of 60 percent of projected sales.

 

Required:

1. What is Master Construction’s Cash Conversion Cycle? (2 marks). Explain in your own words the meaning of this cash conversation cycle (3 marks).

 

2. Calculate Master Construction’s asset turnover (4 marks) and return on asset (4 marks)? Provide two suggestions for how Master Construction can increase its return on asset (4 marks).

 

3. What is the expected return on equity under each of the two working capital policy options? (10 marks).

 

4. Why may the tight policy option not necessarily be the best working capital policy to pursue in the forthcoming financial year?  (3 marks).

Answer rating: 100% (QA)

Answer 1 Cash Conversion Cycle Average Collection Period Days in Inventory Days in Payables In order to calculate the cash conversion cycle three ratios must first be calculated by using key balance s... View the full answer