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 Cutters management is considering a lockbox system to reduce the firms collection times. It is expected that the lockbox system will reduce receipt and deposit times to three days total. Average daily collections are $121,000, and the required rate of return is 6 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? 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? 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. reduction in outstanding cash balances = $125,000*3 = $375,000

b. The return on daily basis will be the average daily interest rate times the cash balance reduction.

Average daily interest rate = (1.05)1/365 - 1 =0.01336% per day

Daily dollar return =  $375,000*0.01336%=$50.10

c. Present value of savings = $125,000 + $125,000 (PV factor0.01336, 2 years) = $125,000 + $125,000(1.9996) = $374,950

Effective monthly interest rate = (1.05)1/12 - 1=0.407%

Considering it as perpetuity,

PV = C/R

C = PV*R = $374,950 * 0.407% = $1526.04 are the monthly payments.

3 b. perpetuity due:

PV = C + C / R

C = (PV

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