Martell-Webb Inc. sells to customers all over the U.S., and payment checks come

Question

Martell-Webb Inc. sells to customers all over the U.S., and payment checks come in to its headquarters in New York City. The firm's average accounts receivable balance is $2.5 million, and they are financed by a bank loan at an 11% annual interest rate. The firm is considering a regional lockbox system to speed up collections, and it believes the lockboxes will reduce receivables by 20%. If the annual cost of the system is $15,000, what would the estimated pre-tax net annual savings be if the firm implements the lockbox system? Show your work.

Explanation / Answer

$40,000 pre-tax savings. 20% * 2.5M = $500,000 reduction in accounts receivables $500,000 A/R * 11% interest = $55,000 interest expense So the $15,000 is far less than the interest expense saved from acquiring the lockbox system. $40,000 pre-tax savings.

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