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.
-Coyote Valley's bank,Grand Lake National,proposes a lock-box collection and processing arrangement that will reduce collection float by 2 days.If the system will cost Coyote Valley $115,000 per year,what is the minimum opportunity cost of funds that would make the system beneficial?

Question

Quizplus · Accepted Answer

The minimum opportunity cost of funds that would make the system beneficial is calculated by dividing the annual cost of the system by the annual savings from reduced collection float. The annual savings from reducing the collection float by 2 days is calculated as follows: Daily cash collections * Days of reduced float * (365 days/year) = $500,000 * 2 * (365/365) = $1,000,000. The cost of the system is $115,000 per year. Therefore, the minimum opportunity cost = ($115,000 / $1,000,000) * 100% = 11.5%.

Coyote Valley Products Has Daily Cash Collections of $500,000