Question

City Farm Insurance has collection centers across the country to speed up collections. The company also makes its disbursements from remote disbursement centers, so the firm's checks will take longer to clear the bank. Collection time has been reduced by two and one-half days and disbursement time increased by one and one-half days because of these policies. Excess funds are being invested in short-term instruments yielding 5 percent per annum. a. If City Farm has $4.90 million per day in collections and $3.90 million per day in disbursements, how many dollars has the cash management system freed up? (Enter your answer in dollars not in millions (e.g., $1,234,567).) Freed-up funds b. How much can City Farm earn in dollars per year on short-term investments made possible by the freed-up cash? (Enter your answer in dollars not in millions (e.g., $1,234,567).) Interest on freed-up cash

Answer 1

Amount of daily collection	= 4,900,000
Reduction in collection period	= 2.5 days
Amount of daily disbursement	= 3,900,000
Increase in disbursement period	= 1.5 days
Cash freed up from Collection	= Amount of daily collection X Reduction in collection period
Cash freed up from Collection	= 4,900,000 X 2.5 days
Cash freed up from Collection	= 12,250,000
Cash freed up from Disbursement	= Amount of daily disbursement X Increase in disbursement period
Cash freed up from Disbursement	= 3,900,000 X 1.5 days
Cash freed up from Disbursement	= 5,850,000
Total cash freed up	= 12,250,000 + 5,850,000 = 18,100,000
Interest Income	= Interest rate X Amount freed up
	= 5% X 18,100,000 = 905,000