Cash Management

QUESTION

Norma s Cat Food of Shell Knob ships cat food throughout the country. Norma has determined that through the establishment of local collection centers around the country, she can speed up the collection of payments by two and one-half days. Furthermore, the cash management department of her bank has indicated to her that she can defer her payments on her accounts by one-half day without affecting suppliers. The bank has a remote disbursement center in Iowa.

If the company has $5 million per day in collections and $3 million per day in disbursements, how many dollars will the cash management system free up Justify your answers.
If the company can earn 8 percent per annum on freed-up funds, how much will the income be? Justify your answers.
If the annual cost of the new system is $800,000, should it be implemented? Explain why or why not.
Solution Given: Collection per day $5 mn Disbursement $3mn The new system will speed up the collections process by 2 1/2 days and defer payments for 1/2 of a day. This will give them a total of 3 days worth of cash on hand at any given time. a. When we then do the math of $5 million $3 million times the 3 days, we get $6 million dollars that the cash management system would free up. b. When we

take 8% of the $6 millions (.08 x 6,000,000) we get $480,000 as the income. c. Since we are only going to have $480,000 as our income and the expense is going to be $800,000, this makes it a poor investment choice as you would not be making any profit on the venture.

ANSWER:

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