Question: (Cash receipts acceleration system) Peggy Pierce Designs Inc. is a vertically integrated, national manufacturer and retailer of women's clothing. Currently, the firm has no coordinated cash management system. A proposal, however, from the First Pennsylvania Bank aimed at speeding up cash collections is being examined by several of Pierce's corporate executives. The firm currently uses a centralized billing procedure, which requires that all checks be mailed to the Philadelphia head office for processing and eventual deposit. Under this arrangement all the customers' remittance checks take an average of 5 business days to reach the head office. Once in Philadelphia, another 2 days are required to process the checks for ultimate deposit at the First Pennsylvania Bank. The firm's daily remittances average $1 million. The average check size is $2,000. Pierce Designs currently earns 6 percent annually on its marketable-securities portfolio. The cash acceleration plan proposed by officers of First Pennsylvania involves both a lockbox system and concentration bank. First Pennsylvania would be the firm's only concentration bank. Lockboxes would be established in
(1) San Francisco,
(2) Dallas,
(3) Chicago, and
(4) Philadelphia.
This would reduce funds tied up by mail float to 3 days, and processing float will be eliminated. Funds would then be transferred twice each business day by means of automated depository transfer checks from local banks in San Francisco, Dallas, and Chicago to the First Pennsylvania Bank. Each DTC costs $15. These transfers will occur all 270 business days of the year. Each check processed through the lockbox system will cost $0.18.
a. What amount of cash balances will be freed up if Peggy Pierce Designs Inc. adopts the system suggested by First Pennsylvania?
b. What is the opportunity cost of maintaining the current banking setup?
c. What is the projected annual cost of operating the proposed system? d. Should Pierce adopt the new system? Compute the net annual gain or loss associated with adopting the system.