Question

W7-5

The Fast Reader Company supplies bulletin board services to numerous hotel chains nationwide. The owner of the firm is investigating the benefit of employing a billing firm to do her billing and collections. Because the billing firm specializes in these? services, collection float will be reduced by 17 days. Average daily collections are $1,300?, and the owner can earn 9% annually? (expressed as an APR with monthly? compounding) on her investments. If the billing firm charges $275 per? month, should the owner employ the billing? firm? The benefits are $ ------. (Round to the nearest? dollar.)

Answer 1

The benefit of outsourcing the billing and collection to the other firm is equal to what Fast Reader can earn on the funds that are freed up.

Since average daily collections are $1,300 and float will be reduced by 17 days, Fast Reader will have an additional ($1,300 per day×17 days). Therefore the benefits are $22,100.

The billing firm charges $275 per month. At an 9% annual rate, the monthly discount rate is 0.75% (9%/12), so the present value of these charges in perpetuity is:

PV = C/R

PV = 275 / 0.0075

PV = 36667

The present value of the cost is $36,667

Fast Reader should not employ the billing firm because present value is higher than benefit.