Jackson’s Thriftway currently processes all of its credit sales at its Seguin, Texas, headquarters. The firm is considering establishing a lockbox arrangement with a Chicago bank to process payments from customers in 12 midwestern states. Average mailing time for customers from this region is currently 4 days. It is expected that the system will reduce this to 2.5 days. Check processing and clearing time would be reduced from 4 days to 1.5 days with the lockbox arrangement. Annual collections from this region are $200 million. The lockbox arrangement would reduce the compensating balance requirement at the firm’s Seguin bank by $400,000 and reduce annual payment processing costs at the Seguin office by $25,000. Funds released by the lockbox arrangement can be invested elsewhere in the firm to earn 14 percent before taxes.
a. The Chicago bank has agreed to process Jackson’s customer payments for an annual fee of $130,000. Determine the annual net pretax benefits to Jackson’s of establishing a lockbox system with the Chicago bank.
b. The Chicago bank has agreed to process Jackson’s customer payments “free of charge” if the firm maintains a minimum compensating balance of $2 million in its account at the bank. Determine the annual net pretax benefits to Jackson’s of establishing the lockbox system under these conditions.