Two banks, First Fidelity Bank and First Union Bank, have offered to process Zack’s retail charge card payments. First Fidelity will process the payments for a fee of $0.15 per payment with no compensating balance required. First Union will process the payments “free of charge,” provided that Zack’s maintains a compensating balance of $3,000,000 at the bank. Zack’s averages 125,000 payments per month from its credit card holders. The company can earn 8 percent before taxes on any available funds.
a. Determine which of the two payment processing proposals Zack’s should accept if the objective is to minimize costs.
b. Determine the rate of return (i.e., Zack’s opportunity cost of funds) at which the costs of the two proposals would be equal.
c. Determine the number of payments per month at which the costs of the two proposals would be equal, assuming that the processing fees ($0.15) and compensating balances ($3,000,000) remain constant.