Question

Cash Management at Richmond Corporation

Richmond Corporation was founded 20 years ago by its president, Daniel Richmond. 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 dispersion of the company’s customers, it currently employs a lockbox system with collection centers in San Francisco, St. Louis, Atlanta, and Boston.

Steve Dennis, the company’s treasurer, has been examining the current cash collection policies. On average, each lockbox center handles $185,000 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 and the proceeds are wire-transferred to Richmond’s headquarters in Dallas to meet the company’s payroll. The investment accounts each pay .068 percent per day and the wire transfers cost .20 percent of the amount transferred.

Steve has been approached by Third National Bank, located just outside Dallas, about the possibility of setting up a concentration banking system for Richmond Corp. Third National will accept the lockbox centers’ 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 will yield .075 percent per day. Each ACH transfer will cost $200. Daniel has asked Steve to determine which cash management system will be the best for the company. Steve has asked you, his assistant, to answer the following questions:

1.What is Richmond Corporation’s total net cash flowfrom the current lockbox system that is available 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 ^could make the company indifferent between the two systems?

please explain in detail.

Answer 1

SOLUTION:-

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

Assumption- number of days in a week= 2

total net cash flow from the current lockbox system available to meet payroll = Future value of cash deposited after two weeks � Wire transfer expense

Future value of cash deposited after two weeks = 185000*(1+0.068%)^13 + 185000*(1+0.068%)^12 + 185000*(1+0.068%)^11 + 185000*(1+0.068%)^10 + 185000*(1+0.068%)^9 + 185000*(1+0.068%)^8 �..185000*(1+0.068%)^3 + 185000*(1+0.068%)^2 + 185000*(1+0.068%)^1 + 185000*(1+0.068%)= $ $2,601,479.00

Wire transfer expense = 0.2%* $2,601,479.00 = $ 5,202.96

total net cash flow from the current lockbox system available to meet payroll = 2,601,479.00-$ 5,202.96= $ 2,596,276.04

2. Under the terms outlined by Third National Bank, should the company proceed with the concentration banking system?

Under the terms outlined by Third National Bank

Future value of cash deposited after two weeks = 185000*(1+0.075%)^13 + 185000*(1+0.075%)^12 + 185000*(1+0.075%)^11 + 185000*(1+0.075%)^10 + 185000*(1+0.075%)^9 + 185000*(1+0.075%)^8 �..185000*(1+0.075%)^3 + 185000*(1+0.075%)^2 + 185000*(1+0.075%)^1 + 185000*(1+0.075%)= $ 2,602,664.21

total net cash flow from the current lockbox system available to meet payroll = $2,602,664.21-200=$2,602,464.21

Yes, the company should proceed with the concentration banking system because the net cash flow is higher

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

For indifference, net cash flow should be equal

$2,602,664.21-Cost =$ 2,596,276.04

Cost= $          6,188.17