Coyote Valley Products
Coyote Valley Products has daily cash collections of $500,000. The cash management staff has determined (1) customers’ payments are in the mail an average of 3 days; (2) processing after receipt averages 1 day; and (3) after deposit funds are cleared on average in 2 days. Assume a 365 day year.

-If Coyote Valley Products faces an 8% opportunity cost of funds,what is the most it would pay to implement a lock-box system that reduces collection float by 2 days?

Question

Coyote Valley Products
Coyote Valley Products has daily cash collections of $500,000. The cash management staff has determined (1) customers’ payments are in the mail an average of 3 days; (2) processing after receipt averages 1 day; and (3) after deposit funds are cleared on average in 2 days. Assume a 365 day year.

-If Coyote Valley Products faces an 8% opportunity cost of funds,what is the most it would pay to implement a lock-box system that reduces collection float by 2 days?

Quizplus · Accepted Answer

To calculate the savings from implementing a lock-box system, we need to first calculate the current collection float:

Current collection float = Mail float + Processing float + Bank float
= 3 days + 1 day + 2 days
= 6 days

If a lock-box system reduces the collection float by 2 days, the new collection float would be:

New collection float = Current collection float - Lock-box reduction
= 6 - 2
= 4 days

The daily cash collections are $500,000, so the average daily float would be:

Average daily float = Daily cash collections x Collection float
= $500,000 x (4/365)
= $5,479.45

The opportunity cost of funds is 8%, so the annual cost of the current float is:

Annual float cost = Average daily float x Opportunity cost of funds x Days in year
= $5,479.45 x 0.08 x 365
= $159,480.12

If Coyote Valley Products implements the lock-box system, the annual float cost would be:

New annual float cost = Average daily float x Opportunity cost of funds x Days in year
= $2,739.73 x 0.08 x 365
= $79,516.28

Therefore, the savings from implementing the lock-box system would be:

Savings = Current annual float cost - New annual float cost
= $159,480.12 - $79,516.28
= $79,963.84

The most Coyote Valley Products should pay for the lock-box system would be the amount that would result in a net savings of $79,963.84. Since the question does not provide any additional information on the cost of a lock-box system or any other related costs, we can only assume that the maximum cost that Coyote Valley Products should pay would be the amount of the net savings, which is $79,963.84 rounded to the nearest $10,000, or $80,000. Therefore, the answer is C.

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