Newman Products has received proposals from several banks to establish a lockbox system to speed up receipts. Newman receives an average of 700 checks... Accounting MCQs | Accounting MCQs

Newman Products has received proposals from several banks to establish a lockbox system to speed up receipts. Newman receives an average of 700 checks per day averaging $1,800 each, and its cost of short-term funds is 7% per year. Assuming that all proposals will produce equivalent processing results and using a 360-day year, which one of the following proposals is optimal for Newman?

A $0.50 fee per check.
A flat fee of $125,000 per year.
A fee of 0.03% of the amount collected.
A compensating balance of $1,750,000.Show Result

Correct - Your answer is correct.

Wrong - Your answer is wrong.

Detailed Answer

Answer (D) is correct. Multiplying 700 checks times 360 days results in a total of 252,000 checks per year. Accordingly, using a $0.50 fee per check, total annual cost is $126,000 (252,000 × $.50), which is less desirable than a $125,000 flat fee. Given that the annual collections equal $453,600,000 (700 checks × $1,800 × 360 days), a fee of 0.03% of the amount collected is also less desirable because the annual fee would be $136,080 ($453,600,000 × .03%). The best option is therefore to maintain a compensating balance of $1,750,000 when the cost of funds is 7%, resulting in a total cost of $122,500 ($1,750,000 × 7%).