Lone Star Technologies has annual sales of $336 million. Management has determined that an average of 8 days elapses between the time customers mail their payments and when the funds are available to the firm. The cost of reducing the float 3 days will be $60,000. Should Lone Star work to reduce the float if the increase in cash can be invested to earn 7.5% per annum? Why or why not?

Question

Quizplus · Accepted Answer

First, we need to calculate the daily cost of reducing the float by 3 days:

Daily cost = $60,000 / 365 days = $164.38 per day

Next, we need to calculate the daily benefit of reducing the float by 3 days:

Daily sales = $336 million / 365 days = $920,547.95 per day
Float reduction = 8 days - 3 days = 5 days
Daily interest earned on float reduction = $920,547.95 * 7.5% / 365 days = $190.04 per day

Therefore, the net daily benefit of reducing the float by 3 days is:

Net daily benefit = $190.04 - $164.38 = $25.66 per day

Multiplying the net daily benefit by the number of days in a year yields the annual savings of reducing the float by 3 days:

Annual savings = $25.66 * 365 days = $9,387.90

Option B is the only answer choice that is close to $9,387.90. Therefore, the best choice is B.

Lone Star Technologies Has Annual Sales of $336 Million