Lockbox system Hardin-Gehr Corporation (HGC) began operations 5 years ago as a s

Question

Lockbox system

Hardin-Gehr Corporation (HGC) began operations 5 years ago as a small firm serving customers in the Detroit area. However, its reputation and market area grew quickly. Today HGC has customers all over the United States. Despite its broad customer base, HGC has maintained its headquarters in Detroit; and it keeps its central billing system there. On average, it takes 6 days from the time customers mail in payments until HGC can receive, process, and deposit them. HGC would like to set up a lockbox collection system, which it estimates would reduce the time lag from customer mailing to deposit by 2 days-bringing it down to 4 days. HGC receives an average of $1,500,000 in payments per day.

How much free cash would HGC generate if it implemented the lockbox system? Round your answer to the nearest cent.
$   

Would this be a one-time cash flow or a recurring one, assuming the company ceases to grow?
-Select-One-time cash flowA recurring cash flowItem 2

How would growth affect your answer?
If the firm grows, cash flow -Select-would be a one-time cash flowwould increase by the differential growthwould decrease by the differential growthItem 3

If HGC has an opportunity cost of 10%, how much is the lockbox system worth on an annual basis? Round your answer to the nearest cent.
$  

What is the maximum monthly charge HGC should pay for the lockbox system? Round your answer to the nearest cent.
$  

Explanation / Answer

It is a problem on cash management. Objective here is to quickly convert payment into cash. Company has a central billing system. asa result it takes 6 days to time from mailing of check to deposit of the same in the bank. This float time can be reduced by a lock box system. In this system customers have to drop the checks at a centrally located lock box. Bank are authorized to collect them from timeto time. This arrangement will reduce float time by 2 days. Thus 2days check value will be converted to free cash if this arrangement is made. Here colection per day is $1,500,000.

Therefore this lock box arrangement will generate free cash equivalent to 2 days average collecion. The amount is

$1,500,000 x 2 = $3,000,000.

-----------------------------------------------------------------------------------------------------------------------------------------------------------

It is not a one time cash flow. There will be a continuous cash flow of this amount. Thus working capital will decrease permanently by this amount. Every day the requirement of working capital will be $3,000,000 less.

----------------------------------------------------------------------------------------------------------------------------------------------------------

If the firm is growing, then its sales will grow continuously. It will mean the average collection per day will also increase. It will mean differential cash flow will also increase.

---------------------------------------------------------------------------------------------------------------------------------------------------------

If you have the opportunity cost of 10%, then this free cash can be used through out the year to earn this amount. Thus your earning is:

$3,000,000 x 10% = $300,000

---------------------------------------------------------------------------------------------------------------------------------------------------------

The extra earnings from free cash can be used to pay monthly charges for lock box. So you can pay

$300,000 / 12 = $25,000 as monthly rental for lock box.

Related Questions

Navigate

• Browse (All)
• Browse L
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.