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I am not been able to understand the requirement and solution of the following question even from the answer provided by examiner. Can you please explain it to me. I shall be very thankful to you.
Question: Crag Co has sales of $200m per year and the gross profit margin is 40%. Finished goods inventory days vary throughout the year within the following range:
Maximum Minimum
Inventory (days) 120 90
All purchases and sales are made on a cash basis and no inventory of raw materials or work in progress is carried.
Crag Co intends to finance permanent current assets with equity and fluctuating current assets with its overdraft.
In relation to finished goods inventory and assuming a 360-day year, how much finance will be needed from the overdraft?
A $10m
B $17m
C $30m
D $40m
Answer: A $200m x 30/360 x 0•6 = $10m
In future you must ask in the Ask the Tutor Forum if you want me to answer – this forum is for students to help each other.
The cost of sales is 200 – (40% x 200) = 120M.
There are 360 days in a year, so the sales per day are 120M/360.The permanent current assets include the minimum inventory of 90 days which will be financed from equity. The fluctuating current assets include the extra 30 days of inventory which will be financed by overdraft.
Therefore financed from overdraft = 30 days x 120M/360 per day = $10M
For more, do watch my free lectures on the management of working capital. The lectures are a complete free course for Paper F9 and cover everything needed to be able to pass the exam well.
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