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Lock Boxes

1. Float. On January 25, Coot Company has $250,000 deposited with a local bank. On January 27, the company writes and mails checks of $20,000 and $60,000 to suppliers. At the end of the month, Coot`s financial manager deposits a $45,000 check received from a customer in the morning mail and picks up the end-of-month account summary from the bank. The manager notes that only the $20,000 payment of the 27th has cleared the bank. What are the company`s ledger balance and payment float? What is the company`s net float?

2. Float. A company has the following cash balances:

Company`s ledger balance = $600,000

Bank`s ledger balance = $625,000

Available balance = $550,000

a. Calculate the payment float and availability float.

b. Why does the company gain from the payment float?

c. Suppose the company adopts a policy of writing checks on a remote bank. How is this likely to affect the three measures of cash balance?

3. Float. General Products writes checks that average $20,000 daily. These checks take an average of 6 days to clear. It receives payments that average $22,000 daily. It takes 3 days before these checks are available to the firm.

a. Calculate payment float, availability float, and net float.

b. What would be General Products`s annual savings if it could reduce availability float to

2 days? The interest rate is 6 percent per year. What would be the present value of these savings?

4. Lock Boxes. Anne Teak, the financial manager of a furniture manufacturer, is considering operating a lock-box system. She forecasts that 300 payments a day will be made to lock boxes with an average payment size of $1,500. The bank`s charge for operating the lock boxes is $.40 a check. The interest rate is .015 percent per day.

a. If the lock box saves 2 days in collection float, is it worthwhile to adopt the system?

b. What minimum reduction in the time to collect and process each check is needed to justify use of the lock-box system?

5. Cash Management. Complete the following passage by choosing the appropriate term from the following list: lock-box banking, wire transfer, payment float, concentration banking, availability float, net float, depository transfer check.

The firm`s available balance is equal to its ledger balance plus the ________ and minus the ________. The difference between the available balance and the ledger balance is often called the ________. Firms can increase their cash resources by speeding up collections. One way to do this is to arrange for payments to be made to regional offices which pay the checks into local banks. This is known as ________. Surplus funds are then transferred from the local bank to one of the company`s main banks. Transfer may be by the quick but expensive ________ or by the slightly slower but cheaper ________. Another technique is to arrange for a local bank to collect the checks directly from a post office box. This is known as ________.

6. Lock Boxes. Sherman`s Sherbet currently takes about 6 days to collect and deposit checks from customers. A lock-box system could reduce this time to 4 days. Collections average $10,000 daily. The interest rate is .02 percent per day.

a. By how much will the lock-box system reduce collection float?

b. What is the daily interest savings of the system?

c. Suppose the lock-box service is offered for a fixed monthly fee instead of payment per check. What is the maximum monthly fee that Sherman`s should be willing to pay for this service? (Assume a 30-day month.)

7. Lock Boxes. The financial manager of JAC Cosmetics is considering opening a lock box in Pittsburgh. Checks cleared through the lock box will amount to $300,000 per month. The lock box will make cash available to the company 3 days earlier.

a. Suppose that the bank offers to run the lock box for a $20,000 compensating balance. Is the lock box worthwhile?

b. Suppose that the bank offers to run the lock box for a fee of $.10 per check cleared instead of a compensating balance. What must the average check size be for the fee alternative to be less costly? Assume an interest rate of 6 percent per year.

c. Why did you need to know the interest rate to answer (b) but not to answer (a)?