Cash Management Paper 5

(d) The requirement is to calculate the financial cost/benefit of establishing a concentration banking arrangement. The cost savings in interest from establishing the arrangement is equal to $9,200 [($115,000 × 2 days) × 4%]. Therefore, answer (d) is correct because implementing the concentration banking arrangement would result in a net savings of $4,200 ($9,200 – $5,000). Answer (a) is incorrect because it only considers the $5,000 cost. Answer (c) is incorrect because it considers the $115,000 in daily cash receipts the benefit.

(d) The requirement is to calculate the financial cost/benefit of establishing a lockbox system. Answer (d) is correct because the solution is found by comparing the cost in fees to the benefits in terms of reduced interest costs. Since the float is reduced by three days the firm gets the use of $1,050,000 ($350,000 × 3 days) in additional funds that results in interest savings of $42,000 ($1,050,000 × 4%). Therefore, the net benefit is equal to $20,000 ($42,000 – $22,000). Answer (a) is incorrect because it only considers the bank fee. Answer (b) is incorrect because it only considers the net change in processing costs.

(c) The requirement is to calculate the financial costs/benefit of establishing a zero balance account system. Answer (c) is correct because the solution is found by comparing the cost in fees to the benefit in terms of reduced interest costs. Since the float is reduced by four days then the firm gets the use of $160,000 ($40,000 × 4 days) additional funds which results in interest savings of $7,200 ($160,000 × 4.5%). The $1,200 savings is the excess of the interest savings of $7,200 over the costs of $6,000. Answer (a) is incorrect because it only considerers the cost without considering the interest savings. Answer (b) is incorrect because it is calculated by considering the $7,200 interest savings as a cost and the $6,000 in maintenance and transfer fees as a benefit. Answer (d) is incorrect because it only considers the interest savings.

(b) The requirement is to identify the working capital technique that increases the payable float. Answer (b) is the correct answer because payment by draft (e.g., a check) is slower than other methods of payment such as electronic cash transfers. Answers (a) and (d) are incorrect because they are techniques designed to speed the processing of cash receipts. Answer (c) is incorrect because EDI involves processing transactions electronically. This would speed up the payment of payables.

(d) The requirement is to determine the optimal agreement for a lockbox system. The number of checks issued during the year is determined by multiplying 700 times 360 days, which results in a total of 252,000 checks. The total amount of collections is equal to $453,600,000 (252,000 checks × $1,800 per check). Answer (d) is correct because it results in the lowest cost of $122,500 ($1,750,000 × 7%), which is the cost of maintaining the compensating balance. Answer (a) is incorrect because it results in a cost of $126,000 ($.50 × 252,000 checks). Answer (b) is incorrect because it results in a cost of $125,000. Answer (c) is incorrect because it results in a fee of $136,080 (3% × $453,600,000).

(d) The requirement is to calculate the annual benefit from accepting the bank’s proposal. Answer (d) is correct because the net benefit from the reduction of the cash receipts float is $12,000 [($100,000 × 2) × 6%] minus the annual service fee, $6,000 ($500 × 12 months), which is equal to $6,000. Answer (b) is incorrect because it ignores the bank service charge. Answer (c) is incorrect because it assumes only a one-day reduction in float.

(b) The requirement is to identify the term used to describe a required minimum checking account balance. Answer (b) is correct because a compensating balance is a minimum balance required by the bank to compensate the bank for services. Answer (a) is incorrect because transactions balance is the amount of funds the firm needs on deposit to conduct day-to-day transactions. Answer (c) is incorrect because this precautionary balance represents the balance available for emergencies. Answer (d) is incorrect because this speculative balance represents the balance available for bargain purchases.

(c) The requirement is to calculate the net benefit from accepting the bank’s proposal. The correct answer is (c) because the annual benefit is $6,000 which is equal to the interest income $12,000 ($100,000 × 2 days × 6%) – $6,000 ($500 × 12) cost.

(b) The requirement is to calculate the net benefit of using the lockbox system. Answer (b) is correct because the net benefit is equal to $60,875, which is equal to the interest savings of $120,000 ($20,000 average payment × 50 payments × 2 days × 6%) minus the cost of the service of $59,125 [$50,000 + (50 payments per day × 365 days × $0.50)].