a. What is the PV of adopting the system? Basic b. What is the NPV of adopting the system? (continued)

c. What is the net cash flow per day from adopting? Per check? Lockboxes and Collections It takes Cookie Cutter Modular Homes, Inc., about five 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 $140,000, and the required rate of return is 10 percent per year.

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

b. What is the dollar return that could be earned on these savings?

c. What is the maximum monthly charge Cookie Cutter should pay for this lockbox system?

Value of Delay Pain Free Dentistry, Inc., disburses checks every two weeks that average $80,000 and take seven days to clear. How much interest can the company earn annually if it delays transfer of funds from an interest-bearing account that pays .02 percent per day for these seven days? Ignore the effects of compounding interest.

NPV and Reducing Float Puddle of Mudd Corporation has an agreement with Lollipop Bank whereby the bank handles $6 million in collections a day and requires a $500,000 compensating balance. Puddle of Mudd is contemplating canceling the agreement and dividing its eastern region so that two other banks will handle its business. Banks A and B will each handle $3 million of collections a day, and each requires a compensating balance of $300,000. Puddle of Mudd's financial management expects that collections will be accelerated by one day if the eastern region is divided. Should the company proceed with the new system? What will be the annual net savings? Assume that the T-bill rate is 4 percent annually.

Lockboxes and Collection Time Bird's Eye Treehouses, Inc., a Kentucky Intermediate company, has determined that a majority of its customers are located in the (Questions 11-12) Pennsylvania area. It therefore is considering using a lockbox system offered by a bank located in Pittsburgh. The bank has estimated that use of the system will reduce collection time by two days. Based on the following information, should the lockbox system be adopted?

Average number of payments per day 700

Average value of payment $1,100

Variable lockbox fee (per transaction) $.35

Annual interest rate on money market securities 6.0%

How would your answer change if there were a fixed charge of $1,000 per year in addition to the variable charge?

Calculating Transactions Required Bumper Crop, Inc., a large fertilizer distributor based in California, is planning to use a lockbox system to speed up collections from its customers located on the East Coast. A Philadelphia-area bank will provide this service for an annual fee of $30,000 plus 10 cents per transaction. The estimated reduction in collection and processing time is one day. If the average customer payment in this region is $6,000, how many customers each

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

VII. Short-Term Financial Planning and Management

20. Cash and Liquidity Management

© The McGraw-Hill Companies, 2002

PART SEVEN Short-Term Financial Planning and Management


(continued ) Challenge

(Question 13)

day, on average, are needed to make the system profitable for Bumper Crop? Treasury bills are currently yielding 5 percent per year.

13. Concentration Banking Mojo Corporation currently employs a lockbox system with collection centers in San Francisco, St. Louis, Atlanta, and Boston. Each lockbox center, on average, handles $150,000 in payments every day. Mojo's current policy is to invest these payments in short-term marketable securities daily at the collection center banks. Every two weeks, the investment accounts are swept and the proceeds are wire-transferred to Mojo's headquarters in Dallas to meet the company's payroll. The investment accounts pay .015 percent per day, and wire transfers cost .15 percent of the amount transferred.

a. What is Mojo's total net cash flow available from its lockbox system to meet the payroll?

b. Suppose Late Nite Bank, located just outside Dallas, offers to set up a concentration bank system for Mojo. Late Nite will accept each of the lockbox center's daily payments via automated clearinghouse, ACH, transfers (in lieu of wire transfers) and deposit the funds in the same marketable securities investments yielding .015 percent per day. ACH-transferred funds are not available for use for one day. If the ACH transfers cost $700 each, should Mojo proceed with the concentration bank plan?

c. In part (b), at what cost of ACH transfers would Mojo be indifferent between the two systems?

On the Web?

target cash balance

A firm's desired cash level as determined by the trade-off between carrying costs and shortage costs.

target cash balance

A firm's desired cash level as determined by the trade-off between carrying costs and shortage costs.

20.1 Commercial Paper Chevron sells commercial paper to interested institutional investors. Go to the Chevron web site at, follow the "Investors" link and the "Commercial Paper" link. What is the credit rating for Chevron's commercial paper? Now follow the link for the commercial paper and find the "Offering Memorandum" link. What is the minimum size Chevron will sell? What size do they request for one- to four-day commercial paper?

20.2 Commercial Paper Rates What are the highest and lowest historical interest rates for commercial paper? Go to and follow the "Interest Rates" link. Find the highest and lowest interest rates for one-, two-, and three-month nonfinancial commercial paper over the time reported. When did they occur?

20.3 ACH Services One provider of float reduction services is ePayment Systems. You can find their web site at Follow the "Services" link and then the "Electronic Check Conversion" link. What does an electronic check conversion accomplish? How does the system work? How long does it take for the funds to be deposited in the merchant's account?

Spreadsheet Templates 20-3, 20-5, 20-6, 20-8

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