It takes Cookie Cutter Modular Homes, Inc., about six days to receive and deposi
ID: 2749418 • Letter: I
Question
It takes Cookie Cutter Modular Homes, Inc., about six days to receive and deposit checks from customers. Cookie Cutter’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 $128,000, and the required rate of return is 5 percent per year. Assume 365 days per year
What is the reduction in outstanding cash balances as a result of implementing the lockbox system?
What is the daily dollar return that could be earned on these savings? (Round your answer to 2 decimal places. (e.g., 32.16))
What is the maximum monthly charge Cookie Cutter should pay for this lockbox system if the payment is due at the end of the month? (Round your answer to 2 decimal places. (e.g., 32.16))
What is the maximum monthly charge Cookie Cutter should pay for this lockbox system if the payment is due at the beginning of the month? (Round your answer to 2 decimal places. (e.g., 32.16))
It takes Cookie Cutter Modular Homes, Inc., about six days to receive and deposit checks from customers. Cookie Cutter’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 $128,000, and the required rate of return is 5 percent per year. Assume 365 days per year
Explanation / Answer
Average daily collections = $ 128,000
Time required to receive and deposit checks into bank = 6 days
Time taken for receipt and deposit of checks time under lockbox = 3 days
Total reduction in time = 6 – 3 = 3 days
Rate of return = 5% pa or 5%/365 = 0.013699% per day
Average float without lockbox = Average daily collection * Number of days required to collect funds
= $ 128,000 * 6 = $ 768,000
Average float with lockbox = Average daily collection * number of days required to collect funds
= $ 128,000 * 3 = $ 384,000
Cash balance deduction due to changeover to Lockbox = $ 768,000 - $ 384,000 = $ 384,000
Dollar return on savings = $ 128000 * 3/365 * 5% = $52. 60274 (rounded off)
This can also be calculated as
Dollar return on savings = $ 128000 * 3 *0.013699% =52.6041 $ (rounded off)
Break-even cost per day will be the bank charge per day at which the net benefit from using lockbox will be zero. That is
Break-even level = Bank charge per day / (daily interest rate * change in time)
That is
Bank Charge per day / (0.013699% * 3 days) = 0
Bank Charge per day = 0.013699% * 3 days = 0.041097%
Amount of charge = $ 128,000 * 0.041097% = $ 52.60416
This is the maximum bank charge per day which makes the company indifferent to lockbox or existing method.
Maximum monthly charge payable if the charges are payable at the end of the month (average month assumed at 30 days)
Maximum monthly charge = Average daily float * 30 days * bank charge per day
= $ 128000 * 30 * 0.041097% = $1578.1248
Maximum monthly charge payable if the charges are payable at the beginning of the month (average month assumed at 30 days)
Maximum monthly charge = 0.041097% * 30 * $ 128000 – (1578.1248*5%/12)
= $ 1578.1248 - $6.57552 = $ 1571.54928
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