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Lockbox, relaxing credit standards, effective annual rate

Problem 1: American Steel and Rubber feels that a lockbox system can shorten its accounts receivable collection period by 2 days. Credit sales are $3,000,000 per year, billed on a continuous basis. The firm has other equally risky investments with a return of 15%. The cost of the lockbox system is $9,000 per year. (Note: Assume a 365-day year.)
a. What amount of cash will be made available for other uses under the lockbox system?
b. What net benefit (cost) will the firm realize if it adopts the lockbox system? Should it adopt the proposed lockbox system?

Problem 2: Failing Financial Enterprises is considering relaxing its credit standards to increase its currently sagging sales. As a result of the proposed relaxation, sales are expected to increase by 20% from 10,000 to 12,000 units during the coming year; the average collection period is expected to increase from 45 to 65 days; and bad debts are expected to increase from 1% to 3% of sales. The sale price per unit is $40, and the variable cost per unit is $31. The firm's required return on equal-risk investments is 25%.

Evaluate the proposed relaxation, and make a recommendation to the firm. (Note: Assume a 365-day year.)

Problem 3: A financial institution made a $100,000, 3-year discount loan at 8% interest, requiring a compensating balance equal to 20% of the face value of the loan. Determine the effective annual rate associated with this loan.
(Note: Assume that the firm currently maintains $0 on deposit in the financial institution.)

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** Please see attached file for complete details/calculations/formulas **

Problem 1: American Steel and Rubber feels that a lockbox system can shorten its accounts receivable collection period by 2 days. Credit sales are $3,000,000 per year, billed on a continuous basis. The firm has other equally risky investments with a return of 15%. The cost of the lockbox system is $9,000 per year. (Note: Assume a 365-day year.)

a. What amount of cash will be made available for other uses under the lockbox system?

Credit sales= $3,000,000 per year
We are assuming a 365 day year
Therefore, Credit sales per day= $8,219 =$3,000,000 / 365

Accounts receivable period is reduced by 2 days
Therefore, cash freed up= $16,438 =$8,219 x 2

Answer: amount of cash that will be made available for other uses under the lockbox system= $16,438

b. What net benefit (cost) will the firm realize if it adopts the lockbox system? Should it adopt the proposed lockbox system?

Return on investment= 15%
Cash freed up= $16,438 (calculated above)
Therefore annual benefit of lock box= $2,466 ...

Solution Summary

Answers 3 questions on lockbox system, relaxing credit standards and effective annual rate on a discount loan.

$2.19