CHAPTER 5

CASH AND LIQUIDITY MANAGEMENT

1. Calculating Float [LO1] In a typical month, the Hampton Corporation

receives 80 checks totaling $139,000. These are delayed four days on average.
What is the average daily float? Assume 30 days in a month.
2. Calculating Net Float [LO1] 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 fi rm after two days. a. Calculate the company’s
disbursement float, collection float, and net float.
b. How would your answer to part (a) change if the collected funds were available
in one day instead of two?
3. Costs of Float [LO1] 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 .017 percent per day. a. What is the company’s float? b.
What is the most Purple Feet should be willing to pay today to eliminate its float
entirely? c. What is the highest daily fee the company should be willing to pay to
eliminate its float entirely?
4. Float and Weighted Average Delay [LO1] Your neighbor goes to the post
offi ce 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?

b. What is the average daily float?

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

5. NPV and Collection Time [LO2] 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?
6. Using Weighted Average Delay [LO1] A mail-order fi rm 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.
- Item 1: 5300 x 43 x 60%= $136,740
- Item 2: 5300 x 75 x 40%= $159,000
- Total amount: $295,740
- Total float of item 1: 136,740 x 2= 273,480
- Total float of item 2: 159,000 x 3= 477,000
- Total float: $750,480
a. What is the average daily collection float? How do you interpret your answer?

the average daily collection float = Total float/total days=

$750,480/30=$25,016
b. What is the weighted average delay? Use the result to calculate the average daily
float.
- the weighted average delay = $136,740/$295,740 x 2 + $159,000/$295,740 x 3 =
- the average daily receipt = $295,740/30= $9,858
- the average daily float= the average daily receipt x the weighted average
delay=
c. How much should the firm be willing to pay to eliminate the float? =$25,016

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

- =$25,016 x 7%= $1,751.12

e. How much should the fi rm be willing to pay to reduce the weighted average
float to 1.5 days?
- the average daily float
- maximum payment=
7. Value of Lockboxes [LO2] Paper Submarine Manufacturing is investigating a
lockbox system to reduce its collection time. It has determined the following:

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?
Average daily collection = 385 x $975 = 375,375

The PV of the lockbox

service = the daily
payments x the number
of days the collection is
reduced
PV =
The PV of the lockbox
service = the daily
payments x the number
of days the collection is
reduced
PV =
The PV of the lockbox service = the daily payments x the number of days the
collection is reduced PV = 375,375 x 3= 1,126,125
b. What is the NPV of adopting the system?

- The PV of the cost = the daily cost / the daily interest rate =
- Daily cost = $0.35 x 385 = 134.75
- PV of cost = 134.75/0.0685%= $196,715.328
- NPV = PV of the service – costs = 1,126,125-196,715.328= 929,409.672
c. What is the net cash flow per day from adopting? Per check?

8. Lockboxes and Collections [LO2] 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 lockbox system?
b. What is the dollar return that could be earned on these savings?

c. What is the maximum monthly charge Cookie Cutter should pay for this lock
box system if the payment is due at the end of the month? What if the payment is
due at the beginning of the month?
9. Value of Delay [LO2] 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.
10. NPV and Reducing Float [LO2] 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.
11. Lockboxes and Collection Time [LO2] 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.
12. Calculating Transactions Required [LO2] 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 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 profitable for Cow Chips?
Treasury bills are currently yielding 5 percent per year, and there are 365 days per
year.
13. Using the BAT Model Given the following information, calculate the target
cash balance using the BAT model:

How do you interpret your answer?

14. Opportunity versus Trading Costs 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?
15. Costs and the BAT Model 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 per cent per year, and selling securities costs $25 per sale.
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?
16. Determining Optimal Cash Balances The All Day Company is currently
holding $690,000 in cash. It projects that over the next year its cash outflows will
exceed cash inflows 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?
17. Interpreting Miller–Orr All Night, Inc., uses a Miller–Orr cash
management approach 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.
18. Using Miller–Orr Slap Shot Corporation has a fixed cost associated with
buying and selling marketable securities of $40. The interest rate is currently .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.
19. Interpreting Miller– Orr 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 fl ow grows. Give an intuitive
explanation for why this happens. What happens if the variance drops to zero?
20. Using Miller–Orr The variance of the daily cash flows for the Pele Bicycle
Shop is $890,000. The opportunity cost to the fi rm 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 established as $160,000? The fi xed cost of buying and selling
securities is $300 per transaction.
21. Using BAT 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?