2-Handout Two- Cash and Marketable Securities Management-Chapter Nine PDF

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Handout Two- Cash and Marketable Securities Management-Chapter Nine P-1: Faisal Communication Company has franchises in Sindh and Punjab. All payments by franchisees for easy paisa services, which average Rs. 420,000 a day, are by check. At present, the overall time between the mailing of the check by the franchisee to Pakistan Post and the time the company has collected or available funds at its bank is six days. A. How much money is tied up in this interval of time? B. To reduce this delay, the company is considering daily pickups from the franchises. In all, three cars would be needed and three additional people hired. This daily pickup would cost Rs. 93,000 on an annual basis, and it would reduce the overall delay by two days. Currently, the opportunity cost of funds is 9 percent, that being the interest rate on marketable securities. Should the company inaugurate the pickup plan? Why? C. Rather than mail checks through Pakistan Post, the company could deliver them by TCS service. This procedure would reduce the overall delay by one day and cost Rs. 10,300 annually. Should the company undertake this plan? Why? P-2: The Shan Company, which can earn 7 percent on money market instruments, currently has a lockbox arrangement with a ABL bank for its Punjab customers. The bank handles Rs. 3 million a day in return for a compensating balance of Rs. 2 million. A. The Shan Company has discovered that it could divide the Punjab into a Central Punjab region (with Rs. 1 million a day in collections, which could be handled by a UBL bank for a Rs. 1 million compensating balance) and a Bahawalpur region (with Rs. 2 million a day in collections, which could be handled by an NBP bank by a Rs. 2 million compensating balance). In each case, collections would be one-half day quicker than with the ABL bank. What would be the annual savings (or cost) of dividing the Central Punjab region? B. In an effort to retain the business, the ABL bank has offered to handle the collections strictly on a fee basis (no compensating balance). What would be the maximum fee the ABL bank could charge and still retain Shan’s business? P-3: The Engro Food Company has a weekly payroll of Rs. 150,000 paid on Friday. On average, its employees cash their checks in the following manner: Day Check Cleared on Company’s Account Percentage of Checks Cashed Friday 20 Monday 40 Tuesday 25 Wednesday 10 Thursday 5 As treasurer of the company, how would you arrange your payroll account? Are there any problems?

Gul Ahmed, Company, has 41 retail clothing outlets scattered throughout the country. Each outlet sends an average of Rs. 5,000 daily to the head office in Karachi, Sindh, through checks drawn on local banks. On average, it takes six days before the company’s Karachi bank collects the checks. Gul Ahmed is considering an electronic funds transfer arrangement that would completely eliminate the float. A. What amount of funds will be released? B. What amount will be released on a net basis if each local bank requires an increase in compensating balances of Rs. 15,000 to offset the loss of float? C. Suppose that the company could earn 10 percent interest on the net released funds in Part (b). If the cost per electronic transfer were Rs. 7 and each store averaged 250 transfers per year, would the proposed arrangement be worthwhile? (Assume that the cost of issuing checks on local banks is negligible.) P-4:

P-5: In the PAGE, or some other financial paper, determine in the money-rate section the rate of interest on Treasury bills, commercial paper, certificates of deposit, and bankers’ acceptances. Do the differentials in return have to do with marketability and default risk? If you were a corporate treasurer of a company with considerable business risk, in what security or securities would you invest? How would you arrange the maturities?

P-6: The Noman Building Supplies Company has annual sales of Rs. 9 million (all credit). On average, it takes five days for a customer’s mailed check to be deposited. Noman believes that he can reduce this float time by two days through the use of a lockbox .The bank will charge a flat fee of Rs. 4,000 per year to perform this service. A. What are average daily sales for January (Assume a 360-day year .) B. All January’s receipts from sales go into a money market mutual fund. By how much will the average balance in this fund increase if Noman adopts the use of the lockbox? C. Suppose that the money market fund earns 10% per year. Should Noman enter into the lockbox agreement? D. Should Noman enter into the lockbox agreement if the money market fund earns 10% but the lockbox reduces float by only one day? P-7: Ruby Department Store has annual credit sales of Rs. 27 million. Faisal, the collection manger, has estimated that it takes six days for a mailed payment to be credited to Ruby’s account and that this time can be cut to three days if Ruby opens up a lockbox account with a local bank. The account in which the checks are placed earns 8% annually. The lockbox agreement calls for a monthly payment of Rs. 500 and, in addition, a monthly charge of Rs. 0.03 per check. Ruby’s currently processes 45,000 checks monthly. (Treat these expenses as if they occur at the beginning of the year.) A. B. C. D.

What are Ruby’s daily sales? (Assume a 360-days year.) By how much will Ruby’s average bank balance increase if it adopts the lockbox? Should Mr. Faisal adopt the lockbox? Suppose that Ruby’s has found that a regular 20% of its customers account for 80% of credit sales. Should Mr. Faisal open up the lockbox and use it only for this 20% of the customers?

P-8: The PSO Oil Company is headquartered in Karachi but has customers in Lahore, Peshawar, Faisalabad, Hyderabad, and Islamabad as well. Khan the collections manager is planning to open collection offices in these cities to speed up the collection process. The rupees volume of collection, the annual cost of running the collections center and the reduction in float time for each city are as follows: A. Using a City Annual Collections Annual Cost of Center Reduction in Float Time in (days) 360 day Lahore Rs. 3000,000,000 Rs. 80,000 1 year, Peshawar 160,000,000 76,000 2 find the Faisalabad 120,000,000 75,000 3 daily Hyderabad 220,000,000 78,000 2 Islamabad 150,000,000 80,000 2 collections from each of the five cities. B. What marginal increase in deposits (because of reduced float) will each city’s collection center contribute to PSO’s deposits? C. Suppose that the rate earned on these accounts is 8% in which cities(if any) should Mr. Khan open up collection centers? P-9: Sitara Fashion Design is evaluating a lockbox system as a cash receipt device has typical year, this firm receives remittances totaling Rs. 7 million by check. The Sitara will record and process 4,000 checks over the same time period. National Bank has informed the management of Sitara Fashion Designs that it will process checks and associated documents through the lock-box system for a unit cost of 25 paisa per check. Sitara Fashion Designs financial manager has projected that cash freed by adoption of the system can be invested in a portfolio of near cash assets that will yield an annual before– tax return of 8 percent. Sitara Fashion Designs financial analysts use 365 day year in their procedures. A. What reduction in check collection time is necessary for Sitara Fashion Designs to be neither better nor worse off for having adopted the proposed system?

B. How would your solution to (A) be affected if Sitara Fashion Designs could invest the fixed balance only at an expected annual per-tax return of 5.5 percent? C. What is the logical explanation for the difference in your answer to (A) and (B) P-10: The Raees Furniture Company of Liaqatabad, Karachi, may install a lockbox system to speed up its cash receipts. On an annual basis, Raees Furniture receives Rs. 10 million in remittances by check. The firm will record and process 15,000 checks over the year. The MCB Bank of Liaqatabad will administer the system at a cost of 35 paisa per check. Cash that is freed up by use of the system can be invested to yield 9 percent on an annual before tax basis. A 365 day year is used for analysis purposes. What reduction in check collection time is necessary for Raees Furniture to be neither better nor worse off for having adopted the proposed system? P-11: IFFCO Manufacturing Company is forecasting that next year’s gross revenues from sales will be Rs. 890 million. The senior treasury analyst for the firm expects the marketable securities portfolio to earn 9.60 percent over this same time period. A 365 day year is used in all the firm’s financial procedures. What is the value to the company of one day’s float reduction? P-12: Nestle, Inc. is investing the possibility of adopting a lock box system as a cash receipts acceleration device. In a typical year, this firm receives remittances totaling Rs. 12 million by check. The firm will record and process 6,000 checks over this same time period. The UBL Bank has informed the management of Nestle that it will expedite checks and associated documents through the lock–box system for a unit cost of 20 Paisa per check. Nestle’s financial manager has projected that cash freed by adoption of the system can be invested in a portfolio of near cash assets that will yield an annual before tax return of 7 percent. Nestle financial analysis use a 365 day year in their procedures. A. What reduction in check collection time is necessary for Nestle to be neither better nor worse off for having adopted the proposed system? B. How would your solution to (a) be affected if Nestle could invest the freed balances only at an expected annual return of 4.5 percent. C. What is the logical explanation for the deference in your answer to (A) and (B) P-13: The Al-Karam will generate Rs. 18 million in credit sales next year. Collections occur at an even rate, and employees work a 270 days year. At the moment the firm’s general accounting department ties up five day’s worth of remittance checks. An analysis undertaken by the firm’s treasurer indicates that new internal procedures can reduce processing float by two days. If Al-Karam invests the released funds to earn 8 percent what will be the annual savings? P-14: The Diamond Foam Company currently has a centralized billing system. Payments are made by all customers to the central billing location. It requires, on average, four days for customers’ mailed payments to reach the central location. An additional day and a half is required to process payments before a deposit can be made. The firm has a daily average collection of Rs. 500,000. The company has recently investigated the possibility of initiating a lockbox system. It has estimated that with such a system customers’ mailed payments would reach the receipt location two and one-half days sooner. Further, the processing time could be reduced by an additional day because each lockbox bank would pick up mailed deposits twice daily. A. Determine how much cash would be freed up (released) through the use of a lockbox system. B. Determine the annual gross dollar benefit of the lockbox system, assuming the firm could earn a 5 percent return on the released funds in Part A by investing in short term instruments. C. If the annual cost of the lockbox system will be Rs. 75,000, should such a system be initiated? P-15: Over the next year, Amereli Steel Company expects the following returns on continual investment in the following marketable securities; treasury bills, commercial papers, and money market preferred stocks are 8.00%, 8.50%, and 7.00% respectively. The company’s marginal tax rate for federal income tax purposes is 30 percent (after allowance for the payment of state income taxes), and its marginal, incremental tax rate with respect to Provincial income taxes is 7 percent. On the basis of after-tax returns, which is the most attractive investment? Are there other considerations?...