Question

2. Drugs R Us operates a mail-order pharmaceutical business in San Francisco. The firm receives an average of $325,000 in payments per day. On average, it takes four days from the time customers mail their checks until the firm receives them. The company is considering establishing a lockbox system, in which customers’ pay- ments would be sent to nearby banks (local in terms of the purchasers) instead of directly to San Francisco. Banks in the lockbox locations would then wire the daily receipts to a single (concentration) bank.

   The lockbox system, which would consist of ten local depository banks and a concentration bank, would cost Drugs R Us a total of $6,500 per month. Under this system, customers’ checks would be received at the ten lockbox locations one day after they are mailed, and the daily total from each of the ten lockbox locations would be wired to the concentration bank at a cost of $9.75 per transfer.

   Assume that the firm could earn 10 percent on short-term investments; further assume 260 working days, and hence 260 transfers from each lockbox loca- tion, per year.

   1. What is the total annual cost of operating the lockbox system?

   2. What is the dollar benefit of the system to Drugs R Us?

   3. Should the firm initiate the lockbox system?

Answer 1

Solution if the lockdown box is implemented the it would cost Drugs R Us a monthly cost of $6500, therefore for a year the total cost would be $6500 * 12 = $78,000 and there is additinal cost for wired transfer from 10 depositories to the concentration bank of $9.75 per transfer = $9.75 * 260 * 10 ( 10 depositories ) = $ 25,350

Therefore total cost would be = $ 78,000 + $ 25,350 = $ 103350

AGAIN , by implementing the lockbox system Drugs R Us is able to save 3 days ( 4-1 ) , hence the savings would be $325,000 * 3 = $ 975,000 , there is 10 % interest on short term investment , therefore the interest earned would be = $975,000 * 10 % = $97,500. This would be the dollar benefit.

But the lockbox system should not be initiated as total cost is more than the benefit i.e ( 103350 - 97500 ) = $-5850.