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City Farm Insurance has collection centers across the country to speed up collections
City Farm Insurance has collection centers across the country to speed up collections. The company also makes its disbursements from remote disbursement centers so the firm's checks will take longer to clear the bank. Collection time has been reduced by two and one-half days and disbursement time increased by one and one-half days because of these policies. Excess funds are being invested in short-term instruments yielding 5 percent per annum.
a. If City Farm has $4.90 million per day in collections and $3.90 million per day in disbursements, how many dollars has the cash management system freed up?
b. How much can City Farm earn in dollars per year on short-term investments made possible by the freed-up cash?
Expert Solution
a. Per Day Collection $ 4,900,000
Since, Collection time has been reduced by two and one-half days, additional collections available are 4,900,000 x 2.5 = $ 12,250,000
Daily disbursements = $3,900,000.
Since, disbursement time has increased by one and one-half days, additional funds available = $3,900,000 x 1.5 = $ 5,850,000
Freed-up funds are $12,250,000 + $5,850,000 = $18,100,000
b. Earnings in dollars per year on short-term investments made possible by the freed-up cash = freed-up funds x interest rate
= $18,100,000 x 0.05 = $ 905,000
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