WashTech Corporation is a franchiser of automatic car washes in the southeast. The company has 420 franchisees that operate 7 days per week. The average gross revenue for each location is $500 per day. The company collects 25% of the gross revenue as its franchise fee. Each franchisee mails a check each day to the company headquarters in Miami. The check is supposed to be mailed by noon each day. Many of the franchisees are lax, however, and payments are forwarded an average of 2 days late. Once mailed, the checks take an average of 1 Vi days in the mail and another 3 days to be processed in the company's receivables department.
Management is considering a change in the company's cash collection method and is considering two proposals, denoted a and b. The company has a 15% before-tax opportunity cost of funds and is subject to an income tax rate of 40%.
(a) Use local messenger services to collect and mail checks. This will save the 2 days of late check forwarding. The messenger service costs $20,000 per year.
(b) Combine messenger service with a lock-box arrangement for a combined savings of 5 days. Costs of this proposal are $20,000 per year for messenger service plus $15,000 that must be left on deposit as a compensating balance required by the bank servicing the lock box.
Required:
Compute the annual change in the company's before-tax income that will result from the each of the two proposals.