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Collection Policy

Major Manufacturing currently has one bank account located in New York to handle all of its collections. The firm keeps a compensating balance of $300,000 to pay for these services (see Section 19.7). It is considering opening a bank account with West Coast National Bank to speed up collections from its many California-based customers. Major estimates that the West Coast account would reduce collection time by 1 day on the $1 million a day of business that it does with its California-based customers. If it opens the account, it can reduce the compensating balance with its New York bank to $200,000 since it will do less business in New York. However, West Coast also will require a compensating

balance of $200,000. Should Major open the new account?

9. Economic Order Quantity. Assume that Everyman`s Bookstore uses up cash at a steady rate of $200,000 a year. The interest rate is 2 percent and each sale of securities costs $20.

a. How many times a year should the store sell securities?

b. What is its average cash balance?

10. Economic Order Quantity. Genuine Gems orders a full month`s worth of precious stones at the beginning of every month. Over the course of the month, it sells off its stock, at which point it restocks inventory for the following month. It sells 200 gems per month, and the monthly carrying cost is $1 per gem. The fixed order cost is $20 per order. Should the firm adjust its inventory policy? If so, should it order smaller stocks more frequently or larger stocks less frequently?

11. Economic Order Quantity. Patty`s Pancakes orders pancake mix once a week. The mix is used up by the end of the week, at which point more is reordered. Each time Patty orders pancake mix, she spends about a half hour of her time, which she estimates is worth $20. Patty sells 200 pounds of pancakes each week. The carrying cost of each pound of the mix is 5 cents per week. Should Patty restock more or less frequently? What is the costminimizing order size? How many times per month should Patty restock?

12. Economic Order Quantity. A large consulting firm orders photocopying paper by the carton. The firm pays a $30 delivery charge on each order. The total cost of storing the paper, including forgone interest, storage space, and deterioration, comes to about $1.50 per carton per month. The firm uses about 1,000 cartons of paper per month.

13. Economic Order Quantity. Micro-Encapsulator Corp. (MEC) expects to sell 7,200 miniature home encapsulators this year. The cost of placing an order from its supplier is $250. Each unit costs $50 and carrying costs are 20 percent of the purchase price.

a. What is the economic order quantity?

b. What are total costs order costs plus carrying costs of inventory over the course of the year?

14. Inventory Management. Suppose now that the supplier in the previous problem offers a 1 percent discount on orders of 1,800 units or more. Should MEC accept the supplier`s offer?

15. Inventory Management. A just-in-time inventory system reduces the cost of ordering additional inventory by a factor of 100. What is the change in the optimal order size predicted by the economic order quantity model?

16. Cash Management. A firm maintains a separate account for cash disbursements. Total disbursements are $100,000 per month spread evenly over the month. Administrative and transaction costs of transferring cash to the disbursement account are $10 per transfer. Marketable securities yield 1 percent per month. Determine the size and number of transfers that will minimize the cost of maintaining the special account.

17. Float Management. The Automated Clearinghouse (ACH) system uses electronic communication to provide next-day delivery of payments. The processing cost of making a payment through the ACH system is roughly half the cost of making the same payment by check. Why then do firms often rationally choose to make payments by check?

18. Float Management. A parent company settles the collection account balances of its subsidiaries once a week. (That is, each week it transfers any balances in the accounts to a central account.) The cost of a wire transfer is $10. A depository transfer check costs $.80. Cash transferred by wire is available the same day, but the parent must wait 3 days for depository transfer checks to clear. Cash can be invested at 12 percent per year. How much money must be in a collection account before it pays to use a wire transfer?

19. Float Management. Knob, Inc., is a nationwide distributor of furniture hardware. The company now uses a central billing system for credit sales of $182.5 million annually. First National, Knob`s principal bank, offers to establish a new concentration banking system for a flat fee of $100,000 per year. The bank estimates that mailing and collection time can be reduced by 3 days.

a. By how much will Knob`s availability float be reduced under the new system?

b. How much extra interest income will the new system generate if the extra funds are used to reduce borrowing under Knob`s line of credit with First National? Assume the interest rate is 12 percent.

c. Finally, should Knob accept First National`s offer if collection costs under the old system are $40,000 per year?

20. Cash Management. If cash flows change unpredictably, the firm should allow the cash balance to move within limits.

a. What three factors determine how far apart these limits are?

b. How far should the firm adjust its cash balance when it reaches the upper or lower limit?

c. Why does it not restore the cash balance to the halfway point?

21. Optimal Cash Balances. Suppose that your weekly cash expenses are $80. Every time you withdraw money from the automated teller at your bank, you are charged 15 cents. Your bank account pays interest of 3 percent annually.

a. How often should you withdraw funds from the bank?

b. What is the optimal-sized withdrawal?

c. What is your average amount of cash on hand?