Question

P15–15Lockbox system Eagle Industries believes that a lockbox system can shorten its accounts receivable collection period by 3 days. Credit sales are $3,240,000 per year, billed on a continuous basis. The firm has other equally risky investments that earn a return of 15%. The cost of the lockbox system is $9,000 per year. (Note: Assume a 365-day year.)

1. What amount of cash will be made available for other uses under the lockbox system?

2. What net benefit (cost) will the firm realize if it adopts the lockbox system? Should it adopt the proposed lockbox system?

Answer 1

Solution a) By applying the lockbox system, the amount of cash available for other uses will be given as:

= Annual Credit Sales*Reduction in collection period/365

= $3,240,000*3/365

= $26,630.14

Solution b) Available rate of return from other risky investments = 15%

With the available cash, the Company can invest it in other risky investments and generate a return of15%  

Thus, interest earned on this extra saved cash = Interest rate*Cash Available for other uses

= 15%*26,630.14

= $3,994.521

Cost of the lockbox system = $9,000

Thus, net benefit (loss) = Interest generated on the available cash - Cost of the system

= 3,994.521 - 9,000

= -$5,005.48

Hence, by adopting the lockbox system, the company would face a loss of -$5,005.48

Thus, the company should not adopt the lockbox system