It takes Cookie Cutter Modular Homes, Inc., about six days to receive and deposi

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 $139,000, and the required rate of return is 5 percent per year. Assume 365 days per year. a. What is the reduction in outstanding cash balances as a result of implementing the lockbox system? b. What is the daily dollar return that could be earned on these savings? c-1. 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? c-2. 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?

Explanation / Answer

a)This one is pretty simple – 3 days x $139,000 = $417,000

b)

First, figure the average daily rate: (1+r)^(1/365)-1 = 1.05^(1/365)-1 = 0.00013368062

Now multiply: $417,000 x .00013368062 = $55.7448, $ 55.75rounded

c1)

Never mind, I figured it out.

First, you need to convert the annual rate to a monthly rate: (1+r)^(1/12)-1 = 1.05^(1/12)-1 = 0.00407412378

For c1 use the perpetuity formula to solve:

PV = c / r
417,000 = c / 0.00407412378
417,000*.0048676 = c
1698.909 = c

Or rounded, $1698.91

c2)

c = (PV * r) / (1+r)
c = (417,000*.0.00407412378) / 1.00407412378
c =

Or rounded, $1705,831

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