Corporate Finance Cash conversion cycle

Running head: CORPORATE FINANCE
Corporate Finance
Name of the Student:
Name of the University:
Author’s Note:

1CORPORATE FINANCE
Table of Contents
Part A: Company Financing............................................................................................................2
Sub part 1:....................................................................................................................................2
Sub part 2:....................................................................................................................................3
Sub part 3:....................................................................................................................................3
Sub part 4:....................................................................................................................................4
Sub part 5:....................................................................................................................................5
Sub part 6:....................................................................................................................................6
Sub part 7:....................................................................................................................................7
Part B: Capital Budgeting................................................................................................................7
Sub part 1:....................................................................................................................................7
Sub part 2:....................................................................................................................................8
Sub part 3:....................................................................................................................................8
Sub part 4:....................................................................................................................................8
Sub part 5:....................................................................................................................................8
Part C: Personal Reflection..............................................................................................................9
References and bibliography:........................................................................................................10

2CORPORATE FINANCE
Part A: Company Financing
Sub part 1:
Cash conversion cycle is the measure of time period required for a business organization
to convert the inputs into output and to sell it and recognize it in cash. It implies the total time
period required to complete a complete cycle of supply chain to realize cash from there. As low
as the cash conversion cycle, the company is more efficient to manage their supply chain and
business to earn revenue and to achieve their organizational goals. From the article “At Amazon,
It’s All About Cash Flow”, it can be observed that the cash conversion cycle of the Amazon is
much lower than that of their competitors Walmart and Costco (Muscettola 2014). It can be
observed that, in the year 2013 the cash conversion cycle of the Amazon was negative. While,
other two competitors, Walmart and Costco was having a positive cash conversion cycle. It can
further be observed that, since 2004, the cash conversion cycle of the amazon was negative,
while the other two competitors were having a positive cash conversion cycle. Amazon’s cash
conversion cycle time was increasing since the year 2010, but still it is negative which implies
their efficient business strategies and cash management system. Cash conversion cycle is
computed adding the days in inventory and days receivables and subtracting the days payable. It
becomes negative when the days payable is more than the sum of days in inventory and days
receivables. Hence, Amazon is able to realize their revenues much faster than the other two
competitors (Muscettola 2014).
Cash management means the management of receivables and payables. It is mainly
related with the collections and credit policies that the company allows to the customers and the
credit period that enjoyed by the company. The better the credit policies the company allows to
the customers, lower would be the days collection period. On the other hand, more flexible the

3CORPORATE FINANCE
credit terms to enjoyed from the suppliers, more indirect short term finances will be there to the
company. It can be observed that, the cash management policies of the company is efficient
enough, which leads to a lower cash collection period and higher credit period enjoyed from the
suppliers. They collect their receivables before the payment for supplies become due (Salas-
Molina Santamaria and Rodriguez-Aguilar 2018).
Sub part 2:
A negative cash conversion cycle implies that the company is having enough amount of
cash available to them before paying off the short term obligations. It also implies that the
available cash is enough to pay off the short term obligations and before the payment becomes
due, they can collect cash again from receivables. Hence, it ensures a liquidity and availability of
funds for investing into new projects and business expansion without borrowing cash from the
outsiders or without raising capital through the issue of equity. If the project gets failed, the also
the company is having enough amount of liquidity and time to recover back the situation. If the
company is not having a negative cash conversion cycle, it would mean that the payment
becomes due much before they collect cash from the receivables. Hence, there will be no
opportunity to invest in expansion project without raising capital from external sources.
Therefore, it is important for the company to have a negative cash conversion cycle to invest into
new expansion projects which is having a possibility of failure (Muscettola 2014).
Sub part 3:
From the given case study, it can be observed that the Amazon is having an expansion
opportunity through investing into new stores. For such an expansion, there is a capital need for
investment in fixed assets and working capital. As the company is having a sound and enough
liquidity deriving from their negative cash conversion cycle, they can use that liquidity to fund

4CORPORATE FINANCE
the expansion project. On the other hand, if they do not want to utilize that cash for the
investment, then they can either raise capital through the issue of equity, or they can borrow
capital from the banks and financial institutions. Hence, except the internal sources of fund, they
can either use the debt capital or the equity capital (Salas-Molina Santamaria and Rodriguez-
Aguilar 2018).
Amazon is having a sound capital structure, which is aimed at minimizing the overall
cost of capital. Cost of debt capital is lower than the equity capital. Deciding the source of capital
for financing the expansion project, the cost of capital and the liquidity of the business is
important. The advantage of the debt capital is that, the cost of debt is lower than the cost of
equity, and the interest is tax deductible. On the other hand, the disadvantage of the debt capital
is that, it affects the liquidity of the company and there is a fixed interest expense burden on the
company. In equity capital there is no such fixed burden of payment and it increases the liquidity
of the company, these can be considered as advantages of the equity capital. On the other hand, it
increases the overall cost of capital, which can be considered as the disadvantage of the equity
capital (Salas-Molina Santamaria and Rodriguez-Aguilar 2018).
Sub part 4:
Particulars 2018
Average inventory $ 16,611
Cost of goods sold $ 139,156
Days inventory outstanding (DIO) 43.57
Accounts receivable $ 14,921
Sales $ 232,887
Days sales outstanding (DSO) 23.38
Accounts payable $ 36,404
Cost of goods sold $ 139,156
Days payable outstanding (DPO) 95.49
Cash conversion cycle (DIO+DSO- (28.53)

5CORPORATE FINANCE
DPO)
It can be observed from the above calculations that Amazon is having a cash conversion
cycle of 28.53 days in negative for the year 2018, while it was 44.50 days in negative for the year
2013. Negative cash conversion cycle, means the greater cash management policies and flexible
credit policies with the suppliers. There are three components in the cash conversion cycle, one
is the Days inventory outstanding, Days sales outstanding and the Days payable outstanding. It
can be observed that in the year 2013 the average credit period allowed by the suppliers was 95.8
days and it lead to a greater negative cash conversion cycle. In the year 2018 also the credit
period allowed by the suppliers is 95.49 days. Hence, there is no much changes in the credit
period allowed or credit policies with the suppliers. Therefore, it can be concluded that the
increase in cash conversion cycle for the Amazon in the year 2018 is mainly caused by higher
receivables collection period and days inventory sales and there is no much change in supplier
relationships (Amazon Annual Report 2018).
Sub part 5:
From the 2018 annual report of the Amazon, it can be observed that the company is
facing an intense competition in its industry which is a greater risk factor to be considered for the
company. The company is adopting various expansion projects which may create an over burden
on the management, finances and available resources of the company. Hence, expansions
projects and the possibilities of its failure are one more risk factor for the Amazon. As there is an
intense competition in the market and they are expanding their business to the new markets and
new product lines, it may cause a significant fluctuation in their revenue and earnings. Amazon
is a global company is the consumer products (Amazon Annual Report 2018). Their global and

6CORPORATE FINANCE
worldwide operation may also create some risk exposures to the company. Business information
and database management is a strong base for the operations of the Amazon. If that could not be
managed well then it may cause a harm to the company. Most of the products sold by the
company are seasonal in nature, seasonality in their business is another risk factor that must be
considered for the Amazon. Multination operation involves currency exchanges. Hence,
exchange rate fluctuation is one more important risk factor for them unlike many other
international companies. Inventory is the stock of finished goods that the company holds for
resale. As in the modern revolutionary age, technologies are ever changing and enhancing, if
new products comes into the market then the old stocks may be obsolete. Hence, over stocking of
inventory is another risk factor for the company (Amazon Annual Report 2018).
It can be understood from the above discussion, that the company is facing various risk
exposures and some of them are controllable and internal in nature while most of them are
market related and uncontrollable in nature. Risks exposures related with the market such as
intense competition, exchange rate fluctuation, relationship with the suppliers are non-
controllable and systematic in nature. The company can have no influence on those factors
through their strategies and diversifications. On the other hand, risks related with the internal
process, financing, inventory, internal data security, are systematic in nature and can be
diversified to a large extent through efficient strategies and diversifications (Amazon Annual
Report 2018).
Sub part 6:
Computation of price of the bond:
Face value of the bond $ 1,000.00
Annual coupon rate 4.50%
Annual coupon payment $ 45.00
Years to maturity 1

7CORPORATE FINANCE
Yield to maturity 5%
Price of the bond in 2019 $ 995.24
Sub part 7:
Computation of holding period return:
Share price at the beginning of June
2014 $ 312.59
Share price at the beginning of June
2019 $ 1,760.01
Total return $ 1,447.42
Holding period return 463.04%
The share price of the Amazon was $312.59 per share at the beginning of June 2014 and
it has been increased to $1,760.01 at the beginning of June 2019. Hence, it has been increased by
$1,447.42, in this holding period starting from June 2014 to June 2019. It implies the holding
period return is 463.04% of the initial investment made in share of the Amazon at the beginning
of June 2014. Amazon is a well-known multination company operating globally with a sound
objective of shareholders wealth maximization. They have been investing capital in various
expansion projects and new products to expand their business operation and to maintain a
sustainable growth in their business. It can be observed from the above computations and
analysis that, the investment made by the company was successful enough to achieve the
objective of the shareholders’ wealth maximization which is reflecting the current share price of
the company.

8CORPORATE FINANCE
Part B: Capital Budgeting
Sub part 1:
Based on the expected sales revenue for the expansion project of 3000 new stores and the
expected expenses the free cash flows of the project has been computed. Please refer to the excel
spread sheet for the detail calculations.
Sub part 2:
Considering a discounting rate of 12% and 5% the net present value of the company is
$2.42 billion and $7.25 billion. As the company is having a speculative revenue, the 12%
discounting rate should be selected. For the detail calculations, please refer to the excel spread
sheet.
Sub part 3:
Considering a discounting rate of 12%, the discounted payback period of the proposed
expansion project is 7.37 years. The expectation of the company is to recover the cash flows
within 2 years of investment. Hence, their target is not realistic.
Sub part 4:
In evaluating the investment proposal for the expansion project, estimation of revenue is
the most important parameter. The estimated revenue of 4.5billion have been taken from the
Bloomberg estimates. In reality the revenues may not be the same as it has been estimated. On
the other hand, the variable costs is a significant part of the expenses, but in the given case study
it has been estimated that, there will be a variable cost of 10% in initial 5 years and 5% in the last
5 years, which is very marginal to the revenue. Hence, the revenue estimates and costs estimates
are not reliable for the analysis (El-Daour and Abu 2014).

9CORPORATE FINANCE
Sub part 5:
The proposed expansion project is having a positive net present value. It has a discounted
payback period of 7.37 years which is beyond their target of 2years, but it is within the life of the
project. Hence, the project can be selected based on the net present value and the discounted
payback period (El-Daour and Abu 2014).
Part C: Personal Reflection
Class case studies in week 1 helps to learn about the meaning of cash management and
different measures of the cash management system. Cash conversion cycle is such an important
method of cash management and evaluation of cash management system. Hence, the class case
studies helped me a lot to learn and understand the calculations of cash conversion cycles and to
analyze the cash management system. It helped me to complete the answers in part 1 of this
assignment.
In part B, the capital budgeting and the evaluation of the investment proposals have been
made. The class studies and class case studies helped me to learn the process and different
methods of capital budgeting and investment appraisal which helped me to compute the free cash
flows in the part B, and to apply the net present value technique and the payback period method
to make a conclusion about the investment decision of the Amazon’s new expansion project.
Lastly, I will be applying all these knowledge and expertise in solving the case study 2 in
class 12 to score best marks possible.

10CORPORATE FINANCE
References and bibliography:
Amazon Annual Report 2018. Available at: https://ir.aboutamazon.com/static-files/0f9e36b1-
7e1e-4b52-be17-145dc9d8b5ec [Accessed 27 Jan. 2020].
Bowden, K.D. and Carpenter, M.B., M3 Technology Solutions LLC, 2014. Cash management
system and method. U.S. Patent Application 14/032,948.
Brooks, R., 2015. Financial management: core concepts. Pearson.
da Costa Moraes, M.B. and Nagano, M.S., 2014. Evolutionary models in cash management
policies with multiple assets. Economic Modelling, 39, pp.1-7.
de Andrés, P., de Fuente, G. and San Martín, P., 2015. Capital budgeting practices in
Spain. BRQ Business Research Quarterly, 18(1), pp.37-56.
El-Daour, J.I. and Abu Shaaban, M., 2014. The use of capital budgeting techniques in evaluating
investment projects: an applied study on the Palestinian corporations working in Gaza
Strip. Journal of Al-Quds Open University, 333(2300), pp.1-85.
Fanning, K., 2015. Benefits of Using a Single‐Account Cash Management Structure. Journal of
Corporate Accounting & Finance, 27(1), pp.35-39.
Imegi, J.C. and Nwokoye, G.A., 2015. The Effectiveness of capital budgeting techniques in
evaluating projects’ profitability. African Research Review, 9(2), pp.166-188.
John, A.O., 2014. Effect of cash management on profitability of Nigerian Manufacturing
firms. International journal of marketing and technology, 4(1), pp.129-140.

11CORPORATE FINANCE
Jordan, B.D., Miller, T.W. and Dolvin, S.D., 2015. Fundamentals of investments: valuation and
management. McGraw-Hill Education.
Muscettola, M., 2014. Cash conversion cycle and firm's profitability: An empirical analysis on a
Sample of 4,226 Manufacturing SMEs of Italy. International Journal of Business and
Management, 9(5), p.25.
Rigopoulos, G., 2014. Real options adoption in capital budgeting: a highlight of recent
literature. Journal of economics and business research, 20(2), pp.41-51.
Rossi, M., 2014. Capital budgeting in Europe: confronting theory with practice. International
Journal of Managerial and Financial Accounting, 6(4), pp.341-356.
Rossi, M., 2015. The use of capital budgeting techniques: an outlook from Italy. International
Journal of Management Practice, 8(1), pp.43-56.
Salas-Molina, F., Pla-Santamaria, D. and Rodriguez-Aguilar, J.A., 2018. A multi-objective
approach to the cash management problem. Annals of Operations Research, 267(1-2), pp.515-
529.
Yazdanfar, D. and Öhman, P., 2014. The impact of cash conversion cycle on firm
profitability. International Journal of Managerial Finance.