Question
Lisa Pinto, vice president of finance at Roche Publishing Company, a rapidly growing publisher of college texts, is concerned about the companys high level of
Lisa Pinto, vice president of finance at Roche Publishing Company, a rapidly growing publisher of college texts, is concerned about the companys high level of short-term negotiated financing. She feels that the firm can improve the management of its cash and, as a result, reduce its heavy reliance on negotiated financing. In this regard, she charged Arlene Bessenoff, the treasurer, with assessing the firms cash management efficiency. Arlene decided to begin her investigation by studying the firms operating and cash conversion cycles. Arlene found that Roches average payment period was 25 days; she consulted industry data, which showed that the average payment period for the industry was 40 days. Investigation of three similar publishing companies revealed that their average payment period was also 40 days. Next, Arlene studied the production cycle and inventory policies. The average age of inventory was 120 days. She determined that the industry standard as reported in a survey done by Publishing World, the trade association journal, was 85 days. Further analysis showed Arlene that the firms average collection period was 60 days. The trade association and three similar publishing companies were found to be 42 days-30 percent lower than Roches. Roche Publishing Company was spending an estimated $14,400,000 per year on its operating cycle investments. Arlene considered this expenditure level to be the minimum that she could expect the firm to disburse during the coming year. Her concern was whether the firms cash management was as efficient as it could be. She estimated that the firm could achieve the industry standards in managing its payables, inventory, and receivables by incurring an annual cost of $120,000. Arlene knew that the company paid 12 percent for its negotiated financing. For this reason, she was concerned about the financing cost resulting from any efficiencies in the management of Roches cash conversion cycle.
Required
1. Assuming a constant rate for purchases, production, and sales throughout the year, what are Roches existing operating cycle (OC), cash conversion cycle (CCC), and negotiated financing need?
2. If Roche can optimize operations according to industry standards, what would its operating cycle (OC), cash conversion cycle (CCC), and negotiated financing need be under these more efficient conditions?
3. In terms of negotiated financing requirements, what is the annual cost of Roche Publishing Companys operational inefficiency?
4. Should the firm incur the $120,000 annual cost to achieve the industry level of operational efficiency? Explain why or why not?
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