Determine the annual earnings on the released funds

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Reference no: EM131336583

Great Lakes Oil Company currently processes all its credit card payments at its domestic headquarters in Chicago. The firm is considering establishing a lockbox arrangement with a Los Angeles bank to process its payments from 10 western states (California, Nevada, Arizona, Utah, Oregon, Washington, Montana, Wyoming, Colorado, and Idaho). Under the arrangement, the average mailing time for customer payments from the western region would be reduced from 3 days to 1.5 days, whereas check processing and clearing time would be reduced from 6 days to 2.5 days. Annual collections from the western region are $180 million.

The total number of payments received annually is 4.8 million (an average of 400,000 credit card customers 12 payments per year). The Los Angeles bank will process the payments for an annual fee of $75,000 plus $0.05 per payment. No compensating balance will be required. Assume that the funds released by the lockbox arrangement can be invested elsewhere in the firm to yield 10 percent before taxes. The establishment of a lockbox system for the western region will reduce paymentprocessing costs at the Chicago office by $50,000 per year. Using this information, determine the following:

a. The amount of funds released by the lockbox arrangement

b. The annual (pretax) earnings on the released funds

c. The annual fee Great Lakes Oil must pay to the Los Angeles bank for processing the payments

d. The annual net (pretax) benefits Great Lakes Oil will receive by establishing this lockbox arrangement with the Los Angeles bank Great Lakes Oil has also received a proposal from a Salt Lake City bank to set up a lockbox system for the firm. Average mailing time for checks in the western region would be reduced to 2 days under the proposal from the Salt Lake City bank, and check processing and clearing time would average 2.5 days. The Salt Lake City bank would not charge any fees for processing the payments, but it would require Great Lakes Oil to maintain a $1.5 million average compensating balance with the bank-funds that normally would be invested elsewhere in the firm (yielding 10 percent) and not kept in a non-interestbearing checking account.

e. Determine the annual net (pretax) benefits to Great Lakes Oil of establishing a lockbox system with the Salt Lake City bank.

f. Which of the two lockbox systems (if any) should the firm select?

Reference no: EM131336583

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