It takes Cookie Cutter Modular Homes, Inc., about six days to receive and deposi
ID: 2467606 • 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 $135,000, and the required rate of return is 4 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? (Round your answer to 2 decimal places. (e.g., 32.16))
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? (Round your answer to 2 decimal places. (e.g., 32.16)
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? (Round your answer to 2 decimal places. (e.g., 32.16))
Explanation / Answer
(a) Reduction in outstanding balances as a result of implementing the lockbox system.
Reduction in outsanding balance = (old balance) - (new balance)
= ( $135,000 x 6 days) - ($135,000 x 3 days)
= $810,000 - $405,000
= $405,000
(b) Daily dollar return that could be earned on these savings.
Calculate the daily return using EAR formula
Effective daily rate = ( 1+ stated interest rate) ^ (1/365) - 1
= ( 1 + 0.04 ) ^ (1/365) - 1
= ( 1 + 0.04) ^ (0.00274) - 1
= 1.000107 - 1
= 0.000107 or 0.0107%
Daily dollar return = Reduction in outstanding balance x effective daily rate
= $405,000 x 0.0107%
= $43.335
(c1) Maximum monthly charge to be paid for this lockbox system if the payment is due at the end of the month.
Savings = 135,000+135,000/ (1.04^(1/365)) + 135,000/(1.04^(1/365))^2
= 134,985.50 + 134,971
= $269,956.50
Maximum monthly charge to be paid = $269,956.50*(1.04^(1/12)-1) = $883.77
(c2) Maximum monthly charge to be paid for this lockbox system if the payment is due at the beginning of the month.
Savings = $269,956.50
Maximum monthly charge to be paid = 269,956.50*(1.04^(1/12)-1)/(1.04^(1/12)) = $880.87
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