Lockbox System. Tunequip, Inc., is a wholesale distributor of specialized audio equipment, tapes, and records. Annual sales are projected at $27 million for the 20X1 fiscal year, and the average accounts receivable balance is estimated at $2.5 million. The average invoice size is $1,000. Customers pay their accounts by check, which are mailed to corporate headquarters in Florida
The finance manager of Tunequip is examining the firm’s cash-handling techniques to find ways to reduce borrowing requirements and financing costs. One alternative under consideration is the establishment of a lockbox system to handle collections from customers in the western United States, Those customers are expected to account for $10.8 million of Tunequip’s total projected sales in 20X1. Tunequip could acquire the use of the funds a day earlier if the western customers mailed their checks to a post office box in Utah. The Utah National Bank would process the payments mailed to the post office box; they would deposit the checks in Tunequip’s account in Utah National, wire transfer the money to the Florida National Bank (Tunequip’s primary bank), and send the payment information by mail. Utah National Bank’s charge for operating the lockbox system would be a flat fee of $80 per month plus $0.10 for each paid invoice handled; in addition the Utah bank would require Tunequip to maintain a $5,000 minimum cash balance with the bank.
There would be no change in Tunequip’s relationship with Florida National Bank. The finance manager estimates that Tunequip would be able to borrow funds from Florida National Bank during 20X1 at an interest rate of 9 percent.
(a) If Tunequip, Inc., established the lockbox system for its western customers, calculate (1) the annual cost of operating the lockbox system, and (2) the dollar amount of the change in the level of accounts receivable and the reduction in borrowing which will result from this system.
(b) What factors other than those referred to in (a) should Tunequip consider in its evaluation of the lockbox system?
(c) Do your calculations support the establishment of a lockbox system for Tunequip’s western customers? Explain your answer. (CMA, adapted.)