Question

Breshna Company has a lockbox arrangement with Azizi Bank for its customer of south zone in Afghanistan. Azizi bank handles 6 million per day in return for a compensating balance of 4 million. Breshna Company can earn 12 percent on money market instruments.

a. The management of Breshna Company is considering an option to divide the south zone into a southeastern zone (with 1.5 million per day collections, and it could be handled by Bakhtar Bank for 1.5 million compensating balance) and a southwestern zone (with 2.5 per day collections, and it could be handled by Ghazanfar Bank for 2.5 million compensating balance) and a south northern zone (with 2 million per day collections, and it could be handled by Afghan United bank for 2 million compensating balance). In each case, the collection would be one day quicker than with Azizi Bank arrangement. What would be the annual saving or cost of dividing the south zone?

b. In order to retain Breshna Company, Azizi Bank offered to handle all the collections on the basis of fee with no compensating balance. What would be the maximum fee that Azizi Bank could charge and still retain Breshna Company?

Answer 1

Cash that will be made available 1 day before=	6	mln
At an additional compensating balance of (6 mln.-4 mln.)=	2	mln.
so, incremental cash flow available to Breshna	4	mln.
Rate of return for the company	12%
So, net annual savings= 4 mln.*12%=	0.48	mln.
	or $ 480000
b. In order to retain Breshna Company, Azizi Bank ,with no compensating balance
the maximum fee that Azizi Bank could charge is
the above $ 480000
(which is also the same as the opportunity cost of interest lost on the compensating balance money required by the bank--- $ 4 mln.* 12% p.a.=0.48 mln.)