A company receives cash inflows of US dollar 6 million per day from customers in
ID: 2724862 • Letter: A
Question
A company receives cash inflows of US dollar 6 million per day from customers in North America. Checks take six days on average to arrive, but a large commercial bank has proposed to implement a lock box-concentration banking system for a dollar 3 million annual fee which would cut the time a check is in receivables float to an average of three days. The company's marginal tax rate is 35 percentage. What is the value of the proposed system to the company, and should it be implemented, if the company's cost of capital is: 8 percentage ? 10 percentage ? 12 percentage ? 15 percentage ?Explanation / Answer
Float value reduction = US$6,000,000 * 3days = $18,000,000
Cost of capital
Tax rate
After tax cost of capital
Float value reduction
Value of proposal
Decision
a.
8%
35%
5.20%
$ 18,000,000
$ 936,000
Should not be implemented
b.
10%
35%
6.50%
$ 18,000,000
$ 1,170,000
Should not be implemented
c.
12%
35%
7.80%
$ 18,000,000
$ 1,404,000
Should not be implemented
d.
15%
35%
9.75%
$ 18,000,000
$ 1,755,000
Should not be implemented
Cost of capital
Tax rate
After tax cost of capital
Float value reduction
Value of proposal
Decision
a.
8%
35%
5.20%
$ 18,000,000
$ 936,000
Should not be implemented
b.
10%
35%
6.50%
$ 18,000,000
$ 1,170,000
Should not be implemented
c.
12%
35%
7.80%
$ 18,000,000
$ 1,404,000
Should not be implemented
d.
15%
35%
9.75%
$ 18,000,000
$ 1,755,000
Should not be implemented
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