Exercises of cash & liquidity management

Ex 1. a. On a typical day, a firm writes checks totaling $3,000. These checks clear in
seven days. Simultaneously, the firm receives $1,700. The cash is available in two
days on average. Calculate the disbursement, collection, and net floats. How do you
interpret the answer?

Disbursement: 3000 x7 = 21000

Collection: -1700 x2= -3400

Net float: 21000 – 3400 = 17600

b. In a typical month, the Hampton Corporation receives 80 checks totaling $139,000.

=(139900x4) /30 = 18533.33

Ex 2. Each business day, on average, a company writes checks totaling $12,000 to pay
its suppliers. The usual clearing time for the checks is four days. Meanwhile, the
company is receiving payments from its customers each day, in the form of checks,
totaling $23,000. The cash from the payments is available to the firm after two days.

a. Calculate the company’s disbursement float, collection float, and net float.

Disburse: 48k

Collection: -46k

Net: 2k

b. How would your answer to part (a) change if the collected funds were available in
one day instead of two?

Collection: -23k

Net: 25k

1
Ex 3. Purple Feet Wine, Inc., receives an average of $17,000 in checks per day. The
delay in clearing is typically three days. The current interest rate is 0.017 percent per
day.

a. What is the company’s float?

Collection: -51k

b. What is the most Purple Feet should be willing to pay today to eliminate its float
entirely?

51k

c. What is the highest daily fee the company should be willing to pay to eliminate its
float entirely?

Interest= -51k x 0.017% = 8.67

Ex 4. Your neighbor goes to the post office once a month and picks up two checks,
one for $14,000 and one for $5,000. The larger check takes four days to clear after it is
deposited; the smaller one takes three days. Assume 30 days in a month.

a. What is the total float for the month?

Disburse: 14x4 +5x3 = 71k

b. What is the average daily float?

Daily: 71k/30 = 2366.66

c. What are the average daily receipts and weighted average delay?

Avg daily receipts: 19k/30=633.33

Weighted avg delay: 4* (14k/19k) + 3* (5k/19k) = 3.77 days

Ex 5. Your firm has an average receipt size of $125. A bank has approached you
concerning a lockbox service that will decrease your total collection time by two days.
You typically receive 6,400 checks per day. The daily interest rate is .016 percent. If
the bank charges a fee of $175 per day, should the lockbox project be accepted? What
would the net annual savings be if the service were adopted?

2
Avg daily collections = 125 x 6400 = 800k

Savings of lockbox service = 800k x 2 = 1,6k

PV of cost = 175/0.016% = 1,093,750

NPV = 1,6k – 1,093,750 = 506,250 >0

Lockbox project should be accepted

Annual saving = 1,6k x (1+0.016%)^365 – 1,6k =

Ex 6. A mail-order firm processes 5,300 checks per month. Of these, 60 percent are
for $43 and 40 percent are for $75. The $43 checks are delayed two days on average;
the $75 checks are delayed three days on

average. Assume 30 days in a month.

a. What is the average daily collection float? How do you interpret your answer?

Avg daily collection float = (43x60%x 5300x2 + 75x 40%x5300x3)/30= 750,480/30=

b. What is the weighted average delay? Use the result to calculate the average daily
float.

Weighted avg delay = 136,470/295,740 x2 + 159,000/295,740 x3 = 2.5358

Avg daily receipt = 295,740/30 = 9,858

Avg daily float = 9,858 x 2.5358 = 24997.91

c. How much should the firm be willing to pay to eliminate the float?

Maximum payment = 24997.91

d. If the interest rate is 7 percent per year, calculate the daily cost of the float.

Daily cost = 24997.91 x 7% = 1,749.85

e. How much should the firm be willing to pay to reduce the weighted average float to
1.5 days?

Avg daily float = 9,858 x (2.5358 – 1.5) = 10,210.91

Maximum payment = 10,210.91

The total collection time will be reduced by three days if the lockbox system is
adopted.

a. What is the PV of adopting the system?

Avg daily collection = 385 x 975 = 375,375

PV = 375,375 x3 = 1,126,125

b. What is the NPV of adopting the system?

PV of cost = Daily cost/ Daily interest = 0.35*385/0.02 = 134.75/0.02% = 673,750

NPV = 1,126,125 – 673,750 = 452,375 >0

c. What is the net cash flow per day from adopting? Per check?

Net cash flow per day = 1,126,125 x 0.02% - 134.75 = 90.475

Net cash flow per check = 90.475/385 = 0.235

Ex 8. It takes Cookie Cutter Modular Homes, Inc., about six days to receive and
deposit checks from customers. Cookie Cutter’s management is considering a lockbox
system to reduce the firm’s collection times. It is expected that the lockbox system
will reduce receipt and deposit times to three days total. Average daily collections are
$130,000, and the required rate of return is 5 percent per year. Assume 365 days per
year.

a. What is the reduction in outstanding cash balances as a result of implementing the

b. What is the dollar return that could be earned on these savings?

4
c. What is the maximum monthly charge Cookie Cutter should pay for this lockbox
system if the payment is due at the end of the month? What if the payment is due at
the beginning of the month?

Ex 9. No More Pencils, Inc., disburses checks every two weeks that average $86,000
and take seven days to clear. How much interest can the company earn annually if it
delays transfer of funds from an interest-bearing account that pays .011 percent per
day for these seven days? Ignore the effects of compounding interest.

Ex 10. No More Books Corporation has an agreement with Floyd Bank whereby the
bank handles $5 million in collections per day and requires a $350,000 compensating
balance. No More Books is contemplating canceling the agreement and dividing its
eastern region so that two other banks will handle its business. Banks A and B will
each handle $2.5 million of collections per day, and each requires a compensating
balance of $200,000. No More Books’ financial management expects that collections
will be accelerated by one day if the eastern region is divided. Should the company
proceed with the new system? What will be the annual net savings? Assume that the T-
bill rate is 2.5 percent annually.

Ex 11. Bird’s Eye Treehouses, Inc., a Kentucky company, has determined that a
majority of its customers are located in the Pennsylvania area. It therefore is
considering using a lockbox system offered by a bank located in Pittsburgh. The bank
has estimated that use of the system will reduce collection time by 1.5 days. Based on
the following information, should the lockbox system be adopted?

How would your answer change if there were a fixed charge of $5,000 per year in
addition to the variable charge? Assume 365 days per year.

Ex 12. Cow Chips, Inc., a large fertilizer distributor based in California, is planning to
use a lockbox system to speed up collections from its customers located on the East
Coast. A Philadelphia-area bank will provide this service for an annual fee of $10,000

5
plus 10 cents per transaction. The estimated reduction in collection and processing
time is one day. If the average customer payment in this region is $5,700, how many
customers each day, on average, are needed to make the system profi table for Cow
Chips? Treasury bills are currently yielding 5 percent per year, and there are 365 days
per year.

Ex 13: Indicate the likely impact of each of the following on a company’s target cash
balance. Use the letter I to denote an increase and D to denote a decrease. Briefly
explain your reasoning in each case:

a. Commissions charged by brokers decrease. D

b. Interest rates paid on money market securities rise. D

c. The compensating balance requirement of a bank is raised. I

d. The firm’s credit rating improves. I

e. The cost of borrowing increases. D

f. Direct fees for banking services are established. D

Ex 14. Given the following information, calculate the target cash balance using the
BAT model:

How do you interpret your answer?

Ex 15. White Whale Corporation has an average daily cash balance of $1,700. Total
cash needed for the year is $64,000. The interest rate is 5 percent, and replenishing the
cash costs $8 each time. What are the opportunity cost of holding cash, the trading
cost, and the total cost? What do you think of White Whale’s strategy?

Ex 16. Debit and Credit Bookkeepers needs a total of $21,000 in cash during the year
for transactions and other purposes. Whenever cash runs low, it sells $1,500 in
securities and transfers the cash in. The interest rate is 4 percent per year, and selling
securities costs $25 per sale.

6
a. What is the opportunity cost under the current policy? The trading cost? With no
additional calculations, would you say that Debit and Credit keeps too much or too
little cash? Explain.

b. What is the target cash balance derived using the BAT model?

Ex 17. The All Day Company is currently holding $690,000 in cash. It projects that
over the next year its cash outfl ows will exceed cash infl ows by $140,000 per month.
How much of the current cash holdings should be retained, and how much should be
used to increase the company’s holdings of marketable securities? Each time these
securities are bought or sold through a broker, the company pays a fee of $250. The
annual interest rate on money market securities is 3.2 percent. After the initial
investment of excess cash, how many times during the next 12 months will securities
be sold?

Ex 18. All Night, Inc., uses a Miller–Orr cash managementapproach with a lower limit
of $43,000, an upper limit of $125,000, and a target balance of $80,000. Explain what
each of these points represents; then explain how the system will work.

Ex 19. Slap Shot Corporation has a fixed cost associated with buying and selling
marketable securities of $40. The interest rate is currently 0.013 percent per day, and
the firm has estimated that the standard deviation of its daily net cash flows is $80.
Management has set a lower limit of $1,500 on cash holdings. Calculate the target
cash balance and upper limit using the Miller–Orr model. Describe how the system
will work.

Ex 20. Based on the Miller–Orr model, describe what will happen to the lower limit,
the upper limit, and the spread (the distance between the two) if the variation in net
cash flow grows. Give an intuitive explanation for why this happens. What happens if
the variance drops to zero?

Ex 21. The variance of the daily cash flows for the Pele Bicycle Shop is $890,000.
The opportunity cost to the firm of holding cash is 4.1 percent per year. What should
the target cash level and the upper limit be if the tolerable lower limit has been

7
established as $160,000? The fixed cost of buying and selling securities is $300 per
transaction.

Ex 22. Rise Against Corporation has determined that its target cash balance if it uses
the BAT model is $5,100. The total cash needed for the year is $31,000, and the order
cost is $10. What interest rate must Rise Against be using?

Ex 23. Company AL has the data of net cash flows for the last 264 days as follows:

NCF ($000) Number of days

b. What is the difference between the lower limit and upper limit of the firm’s cash
balance (based on Miller-Orr model)? The annual interets rate is 12%, cost per
transaction of selling & buying marketable securities is $5, 1 year = 360 days.

c. The minimum requirement of cash balance for the firm’s operation is $200,000.
What should be the maximum cash balance for the firm? What should be the optimal
cash balance?