Q1

XYZ Ltd. is an online book company. The table below summarises the past 2 years of financial statements of XYZ Ltd.

Assume that all sales and purchases are made on credit. Amazon, the biggest competitor, presented a cash conversion cycle (CCC) of –73 days for the same fiscal year of 2015.

Required

• Calculate the CCC of XYZ.
• What is the interpretation of a negative CCC?
• What should XYZ Ltd. do to compete better with Amazon?

Q2

ABC Wines Company is considering the acquisition of a new irrigation system for its extensive vineyards. ABC Wines could either buy the system outright for £10 million or secure a finance lease requiring three annual payments in advance of £3.7 million. The leasing company is not the supplier or manufacturer of the equipment.

The new system is expected to give the following pre-tax net cash savings over the existing system in use:

The system would require replacement in 3 years’ time and have no residual value. The outright purchase would be financed by a loan with an interest rate of 8%.

Assume that corporation tax is charged at 25% and is payable 1 year in arrears. Writing down allowances are available on the depreciation of the equipment. The company uses the reducing balance method for depreciation at 25%. Lease payments are allowable for tax in full.

The company has no gearing at present and a cost of capital of 13%.

Required

• Evaluate whether or not ABC Wines should install the new irrigation system and whether it should use the purchase or the lease option. (Tip: You should use NPV to perform the analysis, and you should take into consideration writing down allowances.)
• Explain the primary ways in which finance leases differ from operating leases.