Question 11.11: A company has to decide whether to require a lock-box servic...
A company has to decide whether to require a lock-box service to process the checks externally. The finance office collected the following information about cash collection:
• Collection is planned to be reduced by 2 days on average.
• Alternative means of investment are available at a daily rate of return of 0.01%.
• The lock-box will receive an average number of 5000 checks per day.
• Each check will be of an average amount of $500.
• The bank charges a processing fee of $0.10 per check and a total fee of $10 to wire the funds.
Based on the information, the average amount of daily collections will be
5000 × 500 = 2, 500, 000 €
A 2-day reduction of the collection period will then correspond to a total benefit of
2, 500, 000 × 2 = 5, 000, 000 €
The cost associated to reducing the float is
5000 × 0:10 = 510 €
Assuming the deal with the bank has not termination, we can assume the cost to be perpetual, with an associated PV of opportunity cost (given the missed opportunity of investing the above sum at the daily rate of return of 0.01%) of
The NPV associated with the adoption of the lock-box system is therefore
5, 000, 000 – 5, 100, 000 = -100, 000
And the lock-box should not be rented.