Question

19. The Hadley Motor Company is located in Florida but has a number of customers in the Pacific Northwest. Sales to those customers are $30 million a year paid in checks that average about $1,500. The checks take an average of nine days to clear into Hadley's Florida bank. A bankin Oregon will operate a lock box system for Hadley for $8,000 a year plus $.50 per check. The system can be expected to reduce the clearing time to six days. a. Is the lock box system worthwhile if Hadley borrows at 13.5%? b. What is the minimum number of days of float time the system has to save (to the nearest tenth of a day) to make it worthwhile?

Answer 1

Given information: Annual sales revenue = $30 million Average check value = $1,500 $ 30 million / $1,500 Hence, the number of total checks in a year is 20,000 checks a.) Present annual borrowing cost: = $30 millions 13.5% *9/365 $99,863 Borrowing cost if we use a lock box system $30 millions 13.5% * 6/365 $66575 Additional cost: Cost of Lock box system per annum - $8,000 - $10,000 Per check cost@$0.50/check (20,000*$0.50) Total cost if we use a lock box system = $84,575 Hence, It is worthwhile to use a lock box system since the cost if we use a lock box system $84,575 is less than the present borrowing cost $99,863

b.) Let "x" be the number of clearing days under the lock box system Then the Borrowing cost under a lock box system Presnt annual borrowing cost - Additional cost under a lock box system $99,863 - ($8,000+$10,000) $99,863 - ($18,000) $99,863 - ($18,000) $81,863 $30 millions 13.5% *x/365 = $30 millions * 13.5% * x/365 $30 millions 13.5% * x/365 $4,050,000 x/365 Therefore, x$81,863 * 365 / $4,050,000 = x 7.38 days Hence, the minimum number of days of float time the system has to save is = 9 days - 7.38 days 1.62 day