Question

It takes Cookie Cutter Modular Homes, Inc., about six days to receive and deposit checks from customers. The company’s management is considering a lockbox system to reduce the firm’s collection times. It is expected that the lockbox system will reduce receipt and deposit times to three days total. Average daily collections are $175,000, and the required rate of return is 4 percent per year. Assume 365 days per year.

It takes Cookie Cutter Modular Homes, Inc., about six days to receive and deposit checks from customers. The company's management is considering a lockbox system to reduce the firm's collection times. It is expected that the lockbox system will reduce receipt and deposit times to three days total. Average daily collections are $175,000, and the required rate of return is 4 percent per year. Assume 365 days per year. a. What is the reduction in outstanding cash balances as a result of implementing the lockbox system? (Do not round intermediate calculations.) b. What is the daily dollar return that could be earned on these savings? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) C-1. What is the maximum monthly charge the company should pay for this lockbox system if the payment is due at the end of the month? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) C-2. What is the maximum monthly charge the company should pay for this lockbox system if the payment is due at the beginning of the month? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) a. Outstanding cash balance reduction b. Daily dollar return C-1. Maximum monthly charge C-2. Maximum monthly charge

Answer 1

a)
Outstanding cash balance reduction = Average daily collections * Number of days
= $175,000 * 3
= $525,000.

b)
Daily dollar return = Outstanding cash balance reduction * ((1 + rate of return)^(1/365)-1)
= $525,000 * ((1 + 4%)^(1/365)-1)
= $525,000 * 0.00010746
= $56.42

c-1)
Payment = PV * Effective monthly rate
= $525,000 * ((1 + 4%)^(1/12) -1)
= $525,000 * 0.00327373978
= $1,718.71

Maximum monthly charge = $1,718.71

c-2)

Maximum monthly charge = $1,718.71 / (1 + 0.00327373978)
= $1,713.11