Question

Donaghy Corporation was founded 20 years ago by its president, Jack Donaghy. The company originally began as a small order company, but has grown rapidly in recent years, in large part due to its website. Because of the wide geographical dispersion of the company’s customers, it current employs a lockbox system with collection centres in Vancouver, Calgary, Toronto and Montreal.

Liz lemon, the company’s treasurer, has been examining the current cash collection policies. On average, each lockbox centre handles $193,000 in payment each day. The company’s current policy is to invest these payments in short-term marketable securities daily at the collection centre banks. Every two weeks, the investment accounts are swept; the proceeds are wire-transferred to Donaghy’s headquarters in Winnipeg to meet the company’s payroll. The investment accounts each earn .012% per day, and the wire transfers cost .20% of the amount transferred.

Liz has been approached by the Royal Canadian Bank about the possibility of setting up a concentration baking system for Donaghy Corp. Royal Canadian will accept each of the lockbox centres daily payments via automated clearinghouse (ACH) transfers in lieu of wire transfers. The ACH-transferred funds will not be available for use for one day. Once cleared, the funds will be deposited in a short-term account, which also yield .012% per day. Each ACH transfer will cost $150. Jack Asked Liz to determine which cash management system will be the best for the company. Liz has asked you, her assistant, to answer the following questions:

1.     What is Donaghy Corporation’s total net cash flow available from the current lockbox system to meet payroll?

2.     Under the terms outlined by the bank, should the company proceed with the concentration baking system?

3.     What cost of ACH transfer would make the company indifferent between the two systems?

Answer 1

1. Donaghy Corporation’s total net cash flow available from the current lockbox system to meet payroll is $2698700 after 2 weeks

2. Yes, the bank should proceed with the concentration banking system, as it would be able to save $3285 (2701985-2698700)

3. The total saving is $3285. If this cost is divided between 14 days (3285/14= $234.6), then $150+$234.6 = $384 ACH transfer cost would make the company indifferent between the two systems

Please refer to the calculations below