Solve The Following Problem: Normas Cat Food Of Shell 927044

Solve The Following Problem Normas Cat Food Of Shell Knob Ships Cat

Norma’s Cat Food of Shell Knob ships cat food throughout the country. Norma has determined that through the establishment of local collection centers around the country, she can speed up the collection of payments by two and one-half days. Furthermore, the cash management department of her bank has indicated to her that she can defer her payments on her accounts by one-half day without affecting suppliers. The bank has a remote disbursement center in Iowa.

If the company has $5 million per day in collections and $3 million per day in disbursements, how many dollars will the cash management system free up? Justify your answers. If the company can earn 8 percent per annum on freed-up funds, how much will the income be? Justify your answers. If the annual cost of the new system is $800,000, should it be implemented? Explain why or why not?

Paper For Above instruction

The problem presented by Norma’s Cat Food of Shell Knob highlights a common financial management strategy aimed at improving cash flow efficiency through optimized receivables and payables processes. It involves assessing the impact of new collection and disbursement systems on the company's cash position, potential income generation from freed-up funds, and a cost-benefit analysis to determine if the proposed system should be implemented.

First, understanding the cash flow cycle is fundamental. The company receives $5 million daily in collections and disburses $3 million daily. The proposed local collection centers will reduce the collection period by 2.5 days, enabling the company to convert receivables into cash more quickly. Simultaneously, the bank's suggestion to defer payments by 0.5 days extends the company's payable period. Both strategies effectively lengthen the company's net float, temporarily increasing the available cash.

The increment in cash due to the new system can be calculated by considering the net float created from faster collections and delayed payments. The reduction in the collection period increases cash on hand by:

  • Daily collections x reduction in collection days = $5 million x 2.5 days = $12.5 million

Similarly, the extension of payment deferment adds to this float, increasing cash by:

  • Daily disbursements x extension in payment period = $3 million x 0.5 days = $1.5 million

Therefore, the total cash management system will free up:

Total freed-up funds = $12.5 million + $1.5 million = $14 million

Next, from an investment standpoint, the company can earn 8% annually on these freed-up funds. To find the annual income generated, we need to determine how much interest is accrued on the $14 million over the year. Assuming the cash is used continuously and the float is maintained, the annual interest income would be calculated as:

Interest income = Freed-up funds x Annual interest rate = $14 million x 8% = $1.12 million

This indicates that, if the company implements the new system to free up $14 million in cash, it could earn approximately $1.12 million annually in interest income, enhancing profitability further.

However, the decision to implement the new system must also consider its costs. The annual cost of the system is given as $800,000. Comparing this cost against the potential financial benefits, which include both the interest income of approximately $1.12 million and the operational advantages, suggests that the implementation could be beneficial. The net benefit, in purely financial terms, would be:

Net benefit = Interest income - System cost = $1.12 million - $800,000 = $320,000

This positive net benefit implies that, financially, the project is favorable. The company would gain an additional $320,000 annually after covering the system's cost. Moreover, improved cash management can lead to other operational benefits, such as better liquidity planning and potentially lower borrowing costs.

In conclusion, based on calculations, the implementation of the new cash management system would free up $14 million, generate approximately $1.12 million in annual interest income, and result in a net benefit of about $320,000. Considering these factors, along with operational improvements, it would be advisable for Norma’s Cat Food to proceed with the new system, provided there are no other hidden costs or risks that could offset these benefits.

References

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