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 $126,000, and the required rate of return is 4 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? (Round your answer to 2 decimal places. (e.g., 32.16))

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))

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))

What is the reduction in outstanding cash balances as a result of implementing the lockbox system?

Explanation / Answer

A./

REDUCTION IN OUTSTANDING CASH BALANCE

= 3DAYS * $126000

= $378000

B./

AVERAGE DAILY RATE

= (1 + 0.04)(1/365) - 1

= 0.00010745978

DAILY DOLLAR RETURN EARNNED

= 0.00010745978 * $378000

= $40.62

C./1./

MONTHLY RATE

= (1 + 0.04)(1/12) - 1

= 0.00327373978

PRESENT VALUE OF PERPETUITY = PERPETUITY / RATE OF RETURN

$378000 = PERPETUITY / 0.00327373978

PERPETUITY = $1237.47

MAXIMUM MONTHLY CHARGE IS $1237.47

C.2./

HERE WE HAVE TO USE PRESENT VALUE OF PERPETUITY DUE

PERPETUITY = (PV OF PERPETUITY * RATE) / (1 + RATE)

= ($378000 * 0.00327373978) / (1 + 0.00327373978)

= $1237.47 / 1.00327373978

= $1233.43

MAXIMUM MONTHLY CHARGE IS $1233.43

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