Question

A company currently receives all customer payments at its headquarters and then send all checks to its bank for processing. This policy leads to a 10-day payment processing cycle. The company is considering asking customers to send their payments directly to a bank lockbox collection system. The new policy would reduce average mailing time for customer payments by 3 days and reduces average check-processing time by 2 days. Annual collections are $365 million, and the average number of payments received total 1000 per day (assume 365 days per year). The bank has agreed to process the payments for an annual fee of $25,000 plus $0.12 per payment received. Assuming the company can earn 10% on released funds, what is the net benefit (NPV) of establishing the new policy?

Answer 1

The net benefit of establishing a new payment processing policy that includes a bank lockbox system is the additional interest earned from released funds minus the cost of the lockbox service. The annual net benefit amounts to approximately $4,931,000 after considering the 5-day cycle reduction and associated fees.

Step-by-step explanation:

The benefit of establishing a new payment processing policy can be determined by calculating the net present value (NPV) of the cash flows resulting from the reduction in the payment processing cycle. Since the cycle is reduced by 5 days (3 days in mailing and 2 days in processing), we can calculate the daily release of funds as a result of the new policy. With collections totaling $365 million annually and 1000 payments per day, the average daily collection is $365 million divided by 365 days, which equals $1 million per day. Hence, 5 days' worth of collections equals $5 million.

The interest that can be earned on this released amount at a 10% annual rate is 10% divided by 365 days, multiplied by $5 million, multiplied by 5 days, which amounts to approximately $13,699 per day. Over the course of a year, this would amount to $13,699 x 365 days = $5 million in additional revenue. The annual cost of the lockbox service is $25,000 plus $0.12 per payment received. Annually, with 1000 payments per day for 365 days, the total fee is $25,000 + (1000 payments/day * $0.12/payment * 365 days) = $69,000. Therefore, the net benefit (benefit minus cost) of the new policy is $5 million - $69,000 = $4,931,000.

Answer 2

The net benefit of adopting the lockbox system is $432,979, calculated by the additional interest income earned from the earlier release of funds due to a reduced payment processing cycle, after accounting for the cost of the lockbox service.

Step-by-step explanation:

The question involves determining the net present value (NPV) of establishing a new lockbox system for a company's payment collections. By shifting customer payments to a bank lockbox, the company can reduce the payment processing cycle by 5 days (3 days in mailing time and 2 days in processing time). With the company collecting $365 million annually, and an average of 1000 payments per day, we can calculate the daily collections as $365,000,000 / 365 = $1,000,000. The lockbox will hence release $1,000,000 of funds 5 days earlier, which at a 10% annual interest rate, converts to an interest income of ($1,000,000 * 5/365 * 10%) = $1,369.86 per day.

The annual cost of the lockbox service is the $25,000 fixed fee plus $0.12 per payment, which totals $25,000 + ($0.12 * 1000 * 365) = $67,000. The annual interest income from the released funds is $1,369.86 * 365 = $499,979. The net benefit is the interest income minus the cost of the lockbox service, which is $499,979 - $67,000 = $432,979.