City Farm Insurance has collection centers across the countryto speed up collect
ID: 2446220 • Letter: C
Question
City Farm Insurance has collection centers across the countryto speed up collections. The company also makes its disbursementsfrom remote disbursement centers so checks written by City Farmtake longer to clear the bank. Collection time has been reduced bytwo days and disburesemtn time increased by one day because ofthese polocies. Excess funds are being invested in short-terminstruments yielding 12 percent per annum. A. If city Farm has $5 million per day in collections and $3million per day in disbursements, how many dollars has the cashmanagement system freed up? B. How much can City Farm earn in dollars per year onshort-term investments made possible by the freed-up cash? Thank You! City Farm Insurance has collection centers across the countryto speed up collections. The company also makes its disbursementsfrom remote disbursement centers so checks written by City Farmtake longer to clear the bank. Collection time has been reduced bytwo days and disburesemtn time increased by one day because ofthese polocies. Excess funds are being invested in short-terminstruments yielding 12 percent per annum. A. If city Farm has $5 million per day in collections and $3million per day in disbursements, how many dollars has the cashmanagement system freed up? B. How much can City Farm earn in dollars per year onshort-term investments made possible by the freed-up cash? Thank You!Explanation / Answer
a. before the change they had $5M coming in and $3 million going out
after they made this change they still have the same amount coming in and going out each day, but during the first few days they freed up money by the changes:
the $5M/day in collections coming in 2 days sooner than before = $10M in extra cash came in SOONER
the $3M in distributions are cashed by customers one day later = $3M in extra cash went out LATER
total $10M+$3M = $13M was "floating" or freed-up
it's not additional income - just the way they collect and pay
if you can't see why this happens put 7 dollar bills in a row on the table ($1/day income for a week)
take the first $1, payment for that day. But you can also take the 3rd $1 because now it is coming in 2 days earlier.
Then take the 2nd dollar for the 2nd day, and the 4th $1 comes in 2 days earlier.
On the 3rd day it's back to normal income - take the 5th $1 that's coming in 2 days sooner. But at that point you are not getting the income from the previous set-up any more.
It may take them a few days to actually get to a point where they have collected the "freed-up" cash.
b. they earn 12% on $13M per year
$13M * 0.12 = $1.56M
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