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 $132,000, 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? Cash balance reduction $ 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)) Dollar return $ 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)) Maximum monthly charge $ 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?

Explanation / Answer

a.

Calculate the reduction in outstanding cash balances as a result of implementing the lockbox system? Cash balance reduction $:

Reduction in outstanding cash balance is (3 days × $132,000) = $396,000

Therefore, reduction in outstanding cash balances is $396,000 because of implementing the lockbox system.

Cash balance is $396,000.

b.

Calculate the daily dollar return that could be earned on these savings:

The average daily rate = (1+r) ^ (1/365)-1

= (1.04) ^ (1/365)-1

= 0.0001074598

Savings = $396,000 × 0.0001074598

= $42.55

Therefore, earned on these savings is $42.55

c-1.

Calculate the maximum monthly charge Cookie Cutter should pay for this lockbox system if the payment is due at the end of the month:

Convert the annual rate to monthly rate = (1+r) ^ (1/12)-1

= (1.04) ^ (1/12)-1

= 0.003274

PV = c/r

$396,000 = c / 0.003274

$396,000 * 0.003274 = c

C = $1,296.504 or rounded to $1,297

c-2:

Calculate the maximum monthly charge Cookie Cutter should pay for this lockbox system and if the payment is due at the beginning of the month:

C = (PV *r) /(1+r)

C = ($396,000 * 0.003274) / 1.003274

C = $1,292.2731

(or) rounded to $1,292.27

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