Question

Your banker has analyzed your company account and has suggested that her bank has a cash management package for you. She suggests that with a concentration banking system, your float can be reduced by three days on average. You, of course, are delighted (you’re not sure why), but you do know your average daily collections amount to $305,000. Your opportunity cost of funds is 9 percent. The bank provides this service for $52,500 plus a compensating balance in your current account of $75,000. (A compensating balance is the amount you are required to maintain interest free at that bank.)

a. Is this package worth it?

• Yes

• No

b. By how much? (Negative answer should be indicated by a minus sign.)

Annual Saving           $

Answer 1

Answer :

(a.) To evaluate whether this package is worth or not :

Calculation of cost of funds saved due to reduction in  the float days

=Average daily collection * Reduction in float days * Opportunity cost of funds

=$305,000 * 3 * 9%

= 82350

Calculation of cost of package = Service fee of Bank + Interest on compensating balance

=52,500 + (75,000*9%)

= 59250

Yes , As the cost of package is less than cost of funds saved due to reduction in  the float days therefore package is worth it.

(b.) Saving = 82350 - 59250

= 23100