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Lockbox system for accounts receivable

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4. (1 point)
A firm has arranged for a lockbox system to reduce collection time of accounts receivable. Currently the firm has an average collection period of 43 days, an average age of inventory of 50 days, and an average payment period of 10 days. The lockbox system will reduce the average collection period by three days by reducing processing, mail, and clearing float. The firm has total annual outlays of $15,000,000 and currently pays 9 percent for its negotiated financing.

(a) Calculate the cash conversion cycle before and after the lockbox system.

(b) Calculate the savings in financing costs from the lockbox system.

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Solution Preview

(a) Calculate the cash conversion cycle before and after the lockbox system.

Cash conversion cycle (CCC) = AR days + Inventory Days - Payable days
Before the lock box system
AR days = 43, Inventory days ...

Solution Summary

The solution explains how to calculate the cash conversion cycle before and after the lockbox system and the savings in financing costs from the lockbox system

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Key Data Regarding Finance Questions

P13-1 Cash conversion cycle American Products is concerned about managing cash efficiently. On the average, inventories have an age of 90 days, and accounts receivable are collected in 60 days. Accounts payable are paid approximately 30 days after they arise. The firm has annual sales of about $30 million. Assume there is no difference in the investment per dollar of sales in inventory, receivables, and payables; and a 365-day year.

a. Calculate the firm's operating cycle.

b. Calculate the firm's cash conversion cycle.

c. Calculate the amount of resources needed to support the firm's cash conversion cycle.

d. Discuss how management might be able to reduce the cash conversion cycle.

P13-7 Accounts receivable changes without bad debts Tara's Textiles currently has credit sales of $360 million per year and an average collection period of 60 days. Assume that the price of Tara's products is $60 per unit and that the variable costs are $55 per unit. The firm is considering an accounts receivable change that will result in a 20% increase in sales and a 20% increase in the average collection period. No change in bad debts is expected. The firm's equal-risk opportunity cost on its investment in accounts receivable is 14%. (Note: Use a 365-day year.)

a. Calculate the additional profit contribution from new sales that the firm will realize if it makes the proposed change.

b. What marginal investment in accounts receivable will result?

c. Calculate the cost of the marginal investment in accounts receivable.

d. Should the firm implement the proposed change? What other information would be helpful in your analysis?

P13-10 Initiating a cash discount Gardner Company currently makes all sales on credit and offers no cash discount. The firm is considering offering a 2% cash discount for payment within 15 days. The firm's current average collection period is 60 days, sales are 40,000 units, selling price is $45 per unit, and variable cost per unit is $36. The firm expects that the change in credit terms will result in an increase in sales to 42,000 units, that 70% of the sales will take the discount, and that the average collection period will fall to 30 days. If the firm's required rate of return on equal-risk investments is 25%, should the proposed discount be offered? (Note: Assume a 365-day year.)

P13-14 Lockbox system Eagle Industries feels that a lockbox system can shorten its accounts receivable collection period by 3 days. Credit sales are $3,240,000 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?

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