Japanese Motors, a major importer of foreign automobiles, has a subsidiary (Japanese Motor Credit Company, or JMCC) that finances dealer inventories, as well as retail installment purchases of the company’s cars. With respect to the financing of retail purchases, JMCC currently employs a centralized billing and collection system. Once a customer’s credit has been approved at one of the subsidiary’s 50 local branch offices, the information is forwarded to JMCC headquarters (located in Los Angeles) and the customer is issued a book of payment coupons. Each month during the life of the installment contract, the customer mails a coupon stub along with the payment to the Los Angeles office. The average mailing, processing, and check-clearing time with the present collection system is 8 days.
In an effort to reduce this collection time, JMCC is considering establishing a decentralized collection system. Under this system, customers would be instructed to mail their payments to the nearest local branch office, which would then deposit the checks in a local bank and report this information to JMCC headquarters in Los Angeles. As the checks clear in the local banks, funds would be sent each day to JMCC’s central bank in Los Angeles. This decentralized collection system would reduce both mailing time and check-clearing time and reduce the average collection time to 5 days.
JMCC’s annual installment collections are $900 million. Implementation of the decentralized collection system is expected to reduce collection costs at the Los Angeles headquarters by $100,000 a year compared with the currently employed centralized collection system. However, branch office collection costs are expected to rise by $225,000 if the decentralized system is implemented. JMCC’s Los Angeles bank currently requires the firm to maintain a $250,000 balance as compensation for depositing customer payments. Compensating balances at the 50 local banks that JMCC would employ with the decentralized collection system are expected to total $500,000. Any funds released under the decentralized collections system would be used to reduce the firm’s debt, which currently carries an interest rate of 7.5 percent.
Using his information, determine the annual net pretax benefits JMCC would realize by implementing a decentralized collection system.