Great Lakes Oil Company currently processes all its credit card payments at its domestic headquarters in Chicago.

Question:

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.

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 payment-processing costs at the Chicago office by $50,000 per year. Using this information, determine the following:: LO1

a. The amount of funds released by the lockbox arrangement

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

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