Question

Marlin Inc. has annual sales of $600 million. Management has determined that an average of 6 days elapses between the time customers mail their payments and when the funds are available to the firm. Third National Bank has a program whereby the float can be reduced by 4 days. The program would cost Marlin $200,000 in annual fixed fees to the bank, as well as a .02% fee on the annual volume of sales. Marlin will also be required to have a compensating balance of $3,000,000 at Third National Bank.

                       

Additionally, Marlin will be able to reduce labor costs in its accounting department by $250,000. Marlin can earn 10 percent (pretax) on its investments.

Show computations which would indicate whether or not Marlin should accept Third National Bank’s proposal.

Answer 1

Reduction in costs for Marlin if it accepts Third National bank's Proposal: Calculate incremental benefit for 2 days (6-4 days)

• Interest gain for 2 days= $600M*10%*2/360=$0.33M (assuming 360 days in a year)
• Gain in Labour cost= $0.25M
• Total benefit=0.33+0.25=$0.58M

Additional Costs to be born if marlin accepts Third National Bank's proposal:

• Annual Fixed Fees=$0.2M
• Other fees on annual sales=$600M*0.02%=$0.12M
• Interest forgone on Compensating balance=$3M*10%=$0.3M
• Total Cost= 0.2+0.12+0.3=$0.62M

Decision: As Costs are greater than benefits, Marlin is better off by not taking services from Third national bank.

Note: Decision may change accordingly if we take 1 year = 240 operating working days.