New Wave Surfing Stuff Inc. is a manufacturer of surfboards and related gear that
sells to exclusive surf shops located in several Atlantic and Pacific mainland coastal
towns as well as several Hawaiian locations. The company’s headquarters are located
in Carlsbad, California, a small southern California coastal town. True to form, the
company’s officers, all veteran surfers, have been somewhat laid back about various
critical areas of financial management. With an economic downturn in California
adversely affecting their business, however, the officers of the company have decided
to focus intently on ways to improve New Wave’s cash flows. The CFO, Willy Bonik,
has been requested to forgo any more daytime surfing jaunts until he has wrapped
up a plan to accelerate New Wave’s cash flows.
In an effort to ensure his quick return to the surf, Willy has decided to focus on
what he believes is one of the easiest methods of improving New Wave’s cash collections,
namely, the adoption of a cash receipts acceleration system that includes a
lockbox system and concentration banking. Willy is well aware that New Wave’s current
system leaves much room for improvement. The company’s accounts-receivable
system currently requires that remittances from customers be mailed to the headquarters
office for processing and then deposited in the local branch of the Bank of
the U.S. Such an arrangement takes a considerable amount of time. The checks take
an average of 5 days to reach the Carlsbad headquarters. Then, depending on the surf
conditions, processing within the company takes anywhere from 2 to 4 days, with
the average from the day of receipt by the company to the day of deposit at the bank
being 3 days.
Willy feels pretty certain that such delays are costly. After all, New Wave’s average
daily collections are $150,000. The average remittance size is $750. If Willy could
get these funds into his marketable-securities account more quickly, he could earn
an annual rate of 5 percent on them. In addition, if he could arrange for someone
else to do the processing, Willy could save $55,000 per year in costs related to clerical
staffing.
New Wave’s banker was pleased to provide Willy with a proposal for a combination
of a lockbox system and a concentration-banking system. Bank of the
U.S. would be New Wave’s concentration bank. Lockboxes would be established
in Honolulu, Newport Beach, and Daytona Beach. Each check processed through
the lockbox system would cost New Wave $0.30. This arrangement, however,
would reduce mail float by an average 2.5 days. The funds so collected would be
transferred twice each day, 270 days a year, from each of the local lockbox banks
to Bank of the U.S. Each transfer would cost $0.35. The combination of lockbox
system and concentration banking would eliminate the time it takes the company to process cash collections, thereby making the funds available for short-term
investment.
a. What would be the average amount of cash made available if New Wave were
to adopt the system proposed by Bank of the U.S.?
b. What is the annual opportunity cost of maintaining the current cash collection
and deposit system?
c. What is the expected annual cost of the complete system proposed by Bank of
the U.S.?
d. What is the net gain or loss that is expected to result from the proposed new
system? Should New Wave adopt the new system?