A company receives cash inflows of US$6 million per day from customers in North
ID: 2724691 • Letter: A
Question
A company receives cash inflows of US$6 million per day from customers in North America. Checks take six days on average to arrive, but a large commercial bank has proposed to implement a lock box-concentration banking system for a $3 million annual fee which would cut the time a check is in receivables float to an average of three days. The company's marginal tax rate is 35%. What is the value of the proposed system to the company, and should it be implemented, if the company's cost of capital is: 8% 12% 10% 15%Explanation / Answer
Float value reduction = US$6,000,000 * 3days = $18,000,000
Cost of capital
Tax rate
After tax cost of capital
Float value reduction
Value of proposal
Decision
a.
8%
35%
5.20%
$ 18,000,000
$ 936,000
Should not be implemented
b.
10%
35%
6.50%
$ 18,000,000
$ 1,170,000
Should not be implemented
c.
12%
35%
7.80%
$ 18,000,000
$ 1,404,000
Should not be implemented
d.
15%
35%
9.75%
$ 18,000,000
$ 1,755,000
Should not be implemented
Cost of capital
Tax rate
After tax cost of capital
Float value reduction
Value of proposal
Decision
a.
8%
35%
5.20%
$ 18,000,000
$ 936,000
Should not be implemented
b.
10%
35%
6.50%
$ 18,000,000
$ 1,170,000
Should not be implemented
c.
12%
35%
7.80%
$ 18,000,000
$ 1,404,000
Should not be implemented
d.
15%
35%
9.75%
$ 18,000,000
$ 1,755,000
Should not be implemented
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