Target Cash Balance 19.2

1. Target Cash Balance 19.2 LO2 • A firm’s desired cash level as determined by the trade-off between carrying costs and shortage costs • Adjustment costs (shortage costs) – costs associated with holding too little cash

2. Payment Payment Payment Cash Mailed Received Deposited Available Mailing Time Processing Delay Availability Delay Collection Delay Cash Collection LO2 One of the goals of float management is to try and reduce the collection delay. There are several techniques that can reduce various parts of the delay.

3. Example: Accelerating Collections – Part I LO2 • Your company does business nationally and currently all cheques are sent to the headquarters in Toronto. You are considering a lock-box system that will have cheques processed in Vancouver and Halifax. The Toronto office will continue to process the cheques it receives in-house. • Collection time will be reduced by 2 days on average • Daily interest rate on T-bills = .01% • Average number of daily payments to each lockbox is 5000 • Average size of payment is $500 • The processing fee is $.10 per cheque plus $10 to wire funds to a centralized bank at the end of each day.

4. Example: Accelerating Collections – Part II LO2 • Benefits • Average daily collections = 3(5000)(500) = 7,500,000 • Increased bank balance = 2(7,500,000) = 15,000,000 • Costs • Daily cost = .1(15,000) + 3*10 = 1530 • Present value of daily cost = 1530/.0001 = 15,300,000 • NPV = 15,000,000 – 15,300,000 = -300,000 • The company should not accept this lock-box proposal

5. Cash Disbursements LO2 • Slowing down payments can increase disbursement float – but it may not be ethical or optimal to do this • Controlling disbursements • Zero-balance account • Controlled disbursement account