Charlie Co. receives an average of 175 cheques a day. The average amount per cheque is $2,100. The firm is considering a lockbox system which it anticipates will reduce the average collection time by 2 days. The bank charges $.25 a cheque for this service. The daily interest rate on Treasury bills is.01 %. What is the net present value of this lockbox arrangement?

Question

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The net present value (NPV) of the lockbox arrangement is calculated by considering the reduction in collection time, the interest earned on the funds, and the cost of the service. The reduction in collection time is 2 days, so the firm will have 2 days' worth of cheques available sooner. The daily interest rate is 0.01%, and the cost per cheque is $0.25. The NPV is calculated as follows:  Daily collections = 175 cheques * $2,100 = $367,500  Interest earned over 2 days = $367,500 * 0.01% * 2 = $73.50  Cost of lockbox service = 175 cheques * $0.25 * 2 days = $87.50  Net benefit per day = $73.50 - $87.50 = -$14  Since the net benefit is negative, the NPV is calculated over a year (365 days):  NPV = -$14 * 365 = -$5,110  However, the correct calculation should consider the total amount accelerated by 2 days, which is $367,500 * 2 = $735,000.  NPV = $735,000 * 0.01% - $87.50 = $297,500.