Question

Bird's Eye Treehouses, Inc., a Kentucky company, has determined that a majority of its customers are located in the 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 2 days. Assume 365 days a year.

Average number of payments per day		780
Average value of payment	$	730
Variable lockbox fee (per transaction)	$	.15
Annual interest rate on money market securities		4.2	%

a.	What is the NPV of the new lockbox system? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
b.	Suppose in addition to the variable charge that there is an annual fixed charge of $5,000 to be paid at the end of each year. What is the NPV now? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

	Q1			Q2			Q3			Q4
Sales	$	180		$	200		$	220		$	250

Sales for the first quarter of the following year are projected at $195 million. Accounts receivable at the beginning of the year were $77 million. Wildcat has a 45-day collection period.

Wildcat’s purchases from suppliers in a quarter are equal to 50 percent of the next quarter’s forecast sales, and suppliers are normally paid in 36 days. Wages, taxes, and other expenses run about 25 percent of sales. Interest and dividends are $10 million per quarter.

Wildcat plans a major capital outlay in the second quarter of $85 million. Finally, the company started the year with a $81 million cash balance and wishes to maintain a $40 million minimum balance.

a-1.

Assume that Wildcat can borrow any needed funds on a short-term basis at a rate of 3 percent per quarter and can invest any excess funds in short-term marketable securities at a rate of 2 percent per quarter. Complete the following short-term financial plan for Wildcat. (Enter your answers in millions. Negative amounts should be indicated by a minus sign. Leave no cells blank - be certain to enter "0" wherever required. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

       

a-2.	What is the net cash cost for the year under this target cash balance? (A negative answer should be indicated by a minus sign. Enter your answer in millions. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

       

b-1.

Complete the following short-term financial plan assuming that Wildcat maintains a minimum cash balance of $20 million. (Enter your answers in millions. Negative amounts should be indicated by a minus sign. Leave no cells blank - be certain to enter "0" wherever required. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

       

b-2.	What is the net cash cost for the year under this target cash balance? (Enter your answer in millions. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

       

Answer 1

Answer-a:

Reduction in collection = 2 days

Value of collection for 2 days = 2*780*730 = $ 1,138,800 (is the cash realesed by the system)

Lock box fee payble per day = 780 * $0.15 = $ 117

Interest = 4.2%

The PV of the lock box service is the average daily receipts times the no of days collection is reduced = $1,138,800

The lock box cost per day of $ 117 is a perpetuity, whose PV is given by the daily cost/interest rate per day

= 117/(.042/365) = 117/0.000115068

= $ 1,016,785

Therefore, NPV of the lock-box system = $1,138,800 - $1,016,785 = $ 122,015

Answer-b:

If the Bank charges a fixed fee of $ 5,000 per year in addition to the variable fee.

In such a case the PV of this fee, which is a perpetuity should be taken as an additional cost = $5,000/0.042 = $ 119,048

NPV of the lock box system with the additional fixed fee = $122,015 - $ 119,048 = $ 2,967

As the NPV is still positive, the lock box system can be accepted with the additional fixed fee also.