Page 224 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Unit 13: Integration of Working Capital and Capital Investment Process

Notes
Did u know? What are treasury bills?
The securities with a maturity of between three to twelve months, at the time of issues, are
called treasury bills. The sales are carried out by the RBI, on behalf of the Central
Government, to raise short-term finance for the Government and observe excess liquidity
in the market.
The firm can deposit its excess cash with the commercial banks for some fixed maturity.
Deposit scheme are tailored suiting to the needs of the depositors. By various combinations
of Demand, Term and Recurring Deposits, banks have brought spectrum of deposit schemes.
Bank deposits are very popular due to their safe character. An individual depositor gets
protection to the extent of ` 20,000 from the Deposit Insurance Corporation. Besides, the
RBI also exercises a strict surveillance over the banking system which also ensures safety
of deposits.

Example: A firm is currently disbursing from its concentration bank at a cost of ` 25 per
month for account maintenance and `10 per cheque processed. The controlled disbursement
bank will charge `75 per month for account maintenance and `15 per cheque processed. The
controlled disbursement account will add 1/2-day float to the disbursements. The company
issues 100 cheques of average face amount of ` 2,500 per day. The treasurer maintains an overnight
portfolio of about `10,00,000, on which she currently earns about 6% per annum. She estimates
that she could earn an additional 25 basis points on the investments if she could invest earlier in
the day. Transfers to the controlled disbursement account could be done at a cost of ` 1 per
transfer. Determine the annual net benefit, or cost, of using the controlled disbursement account
instead of the current system.
Solution:
The net benefits consist of the float benefits plus the gain on the earlier investment less the
additional costs connected with the controlled disbursing account less the transfer costs.
Float benefits are:
annual disbursement × float gain × Investment rate
(` 2,500 per day × 100 × 250 days) × (.5 days) × (.06/365) = ` 5,137

Additional investment benefits are:
Amount of the investment portfolio × Incremental rate (`10,00,000) × (.0025) = `2,500.
Incremental bank charges are:
Incremental account maintenance costs + incremental per item charges

(` 75 – ` 25) × 12 + (` .15 × ` .10) × 100 × 250 = `1,850
Transfer costs are: ` 1 × 250 = `250.
The net benefits are:
Float benefits + Investment benefits – Additional costs – Transfer costs

` 5,137 + `2,500 – `1,850 – `250 = ` 5,537
Total reduced costs = `1 ,01 ,250 + `52,000 = ` 1,53,250
Maximum acceptable compensating balance = `1,53,250/0.15 = `10,21,666.60

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