ExpertMedium1 markMultiple Choice
CPA · Question 21 · Area I: Business Analysis
A company is considering a lockbox system to accelerate cash collections. The system will cost $5,000 per month. It is expected to reduce the average collection float by 3 days. Average daily collections are $200,000. The company's short-term borrowing rate is 6%. What is the net annual benefit (or cost) of adopting the system?
A company is considering a lockbox system to accelerate cash collections. The system will cost $5,000 per month. It is expected to reduce the average collection float by 3 days. Average daily collections are $200,000. The company's short-term borrowing rate is 6%. What is the net annual benefit (or cost) of adopting the system?
Answer options:
A.
$36,000 Benefit
B.
$24,000 Cost
C.
$24,000 Cost
D.
$11,000 Benefit
How to approach this question
1. Calculate cash freed up (Days saved × Daily collections). 2. Calculate interest savings (Cash freed × Interest rate). 3. Subtract annual cost of system.
Full Answer
C.$24,000 Cost✓ Correct
C
Benefit: Accelerating collections by 3 days frees up 3 × $200,000 = $600,000 in cash. This cash can be used to pay down debt at 6%. Savings = $600,000 × 0.06 = $36,000/year. Cost: $5,000/month × 12 = $60,000/year. Net Impact = $36,000 - $60,000 = ($24,000) Net Cost.
Common mistakes
Forgetting to annualize the monthly cost; calculating interest on daily collections instead of total freed cash.
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