Financial management revision question and answer

CPA-Financial-Management-Section-3 Revision kit

Munyu Ltd. currently has a centralized billing system. All payments are made customers to a central billing location. It requires an average of eight days for customers mailed payments to reach the central location. An additional three days are required to process payments before a deposit can be made into the bank account. The firm has a daily average collection of sh.10,000,000. Recently the bank has investigated the possibility of initiating a lockbox system. It is estimated that if the system is introduced customers mail payments will reach the receipt location five days sooner

than is the case now. Furthermore, the processing time of the payments could be reduced to one day.

Required:
(i) The reduction in cash balances in transit to the bank brought about the lockbox system.
(ii) The opportunity cost of the present system assuming a 5 per cent per annum return on deposits at the bank.
(iii) In light of your answer to part (ii) above, should the lockbox system be introduced, if it will cost Shs. 4,000,000?
ANSWER

(iii) Since opportunity cost is less than cost of lockbox, the lockbox should not be introduced.

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