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 $120,000, 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))

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 $120,000, and the required rate of return is 4 percent per year. Assume 365 days per year.

Explanation / Answer

a) Reduction in outstanding cash balances = days saved * collections per day

    = 3*120000 = $360,000

b) Daily dollar return =

The daily interest rate = 1.04^1/365 – 1 = 0.00010746

Therefore the daily dollar return = 360000*0.00010746 = $38.69

c) With the lockbox, the firm will receive three payments early, with the first payment occurring on day 1. The savings are:

Savings = $120,000 + $120,000(PVIFA.010746,2)

Savings = 120000+120000*1.9997 = 359964

i)     If the lockbox payments occur at the end of the month, the effective monthly interest rate is:

       Monthly interest rate = 1.041/12 – 1 = 0.3273%

       Assuming the lockbox payments occur at the end of the month, the lockbox payments, which are a perpetuity, will be:

               PV = C/R

               359964 = C / .003273

               C = 1,178.16

ii)    If the lockbox payments occur at the beginning of the month, it is the PV of a perpetuity due, which is:

               PV = C + C / R

               Solving for C:

               C = (PV × R) / (1 + R)

               C = (359964*0.003273) / (1 + .003273)

               C = 1,174.32

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