Question

Webb Corporation was founded 20 years ago by its president, Bryan Webb. The company originally began as a mail-order company, but has grown rapidly in recent years, in large part due to its website. Because of the wide geographical disper- sion of the company’s customers, it currently employs a lock- box system with collection centers in San Francisco, St. Louis, Atlanta, and Boston. Holly Lennon, the company’s treasurer, has been exam- ining the current cash collection policies. On average, each lockbox center handles $193,000 in payments each day. The company’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; the pro- ceeds are wire-transferred to Webb’s headquarters in Dallas to meet the company’s payroll. The investment accounts each earn .012 percent per day, and the wire transfers cost .20 per- cent of the amount transferred. Holly has been approached by Third National Bank, lo- cated just outside Dallas, about the possibility of setting up a concentration banking system for Webb Corp. Third National will accept each of the lockbox center’s daily payments via automated clearinghouse (ACH) transfers in lieu of wire trans- fers. 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 will yield .012 percent per day. Each ACH transfer will cost $150. Bryan has asked Holly to determine which cash management system will be the best for the company. As her assistant, Holly has asked you to answer the following questions.

QUESTIONS
1.   What is Webb Corporation’s total net cash flow available from the current lockbox system to meet payroll?
2.   Under the terms outlined by Third National Bank, should the company proceed with the concentration banking system?
3.   What cost of ACH transfers would make the company indifferent between the two systems?

Answer 1

1)

Total cash available for investment each day = 193000*4 = $772,000

Future value of daily investment (14 days period, daily interest rate of 0.012%) = 772,000*FVAF(0.012%,14) = 772,000*[((1+0.012%)^14)-1]/0.012% = 772,000*14.0109 = $10,816,434.29

Amount available for payroll = Value of investment*(1-transfer cost) = 10,816,434.29*(1-0.20%) = 10,794,801.42

2)

Cash flow calculations under the terms outlined by Third National Bank:

Cash available for 14 days inestment = Number obranches*(daily payments-tfr cost) = 4*(193000-150) = $771,400

FV of investment (14 days @ 0.012% yield per day) = 771,400*FVAF(0.012%,14 days) = 771,400*14.0109 = $10,808,027.73

Since these payments will be invested after 1 day, we need to discount it for 1 day time = 10,808,027.73/(1+0.012%) = $10,806,730.92, which is the cash avilable under this scenario.

Since the cash available under the terms of Third National Bank is higher than under the current system, the company should accept the offer.

3)

Let the cost of ACH transfer be X, at which the company will be indifferent between two options:

Therefore:

10794801.42 = (4*(193000-X)*14.0109)/(1+0.012%),

Solving for X, X = $362.89

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