Sun Magic Corp. consistently sells $60 million of product sales (with a cost of goods sold of $40 million) each year. Sun's inventory ratio has been 4.0 for the past few years. A new VP of Operations believes that a new inventory control system will increase inventory turnover to 6.0 without impacting sales. If the new VP is correct, how much working capital will be freed up?
| a. |
It cannot be determined from the information provided. |
|
| b. |
$2.0 million |
|
| c. |
$6.7 million (rounded). |
|
| d. |
$3.3 million (rounded) |
Inventory turnover ratio = 4
Cost of goods sold = $40 million
Average inventory = ?
Inventory turnover ratio = Cost of goods sold/Average inventory
4 = 40/Average inventory
Average inventory = $10 million
A new VP of Operations believes that a new inventory control system will increase inventory turnover to 6.0 without impacting sales.
New inventory turnover ratio = Cost of goods sold/Average inventory
6 = 40/Average inventory
Average inventory = $6.7 million
Hence, If the new VP is correct, freed up working capital will be = Average inventory (before) - Average inventory (after)
= 10 - 6.7
= $3.3 million (rounded)
Correct option is (d)
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