JKL Industries requires its branch offices to transfer cash balances once per week to the central corporate account. A wire transfer costs $12 and assures the cash is available the same day. A depository transfer check (DTC) costs $1.50 and generally results in funds being available in 2 days. JKL's cost of short-term funds averages 9%, and they use a 365-day year in all calculations. What is the minimum transfer amount that would justify the cost of a wire transfer as opposed to a DTC? (Round answer up to the next hundred.)
Below is the answerMy concern is that why not X * 0.0005 -12= 1.5? as X * 0.0005 -12 represent the net benefit of wire transfer?
If the co. go for DTC it will cost it $1.50 and will take two days for funds to be available and if it will go for wire transfer it will cost JKL $12 and funds will be available same day.
So the excess amount that JKL will pay over DTC would be = $12 - $1.50 = $10.5
Now if the co. goes for DTC they can borrow money for two days at 9% . Thus interest charge for two days would be = 0.09/360 X 2 =0.0005
Lets suppose that $10.5 (calculated earlier) is the interest charge that the co. will be paying if it will choose DTC and X is the total amount of transfer
So the minimum transfer amount that would justify the cost of wire transfer would be
X * 0.0005 = $10.5
or X = 10.5 / 0.0005 = $21,000
i.e. if the co. is transfering any amount less than $21,000 it should go for DTC as it will cost them less but if the amount is $21,000 or more they should go for wire transfer as it will save them money.
The minimum transfer amount occurs when the net benefit of the wire transfers is equal to the cost of the DTC. The net benefit of the transfers is equal to the interest for 2 days saved, less the annual wire transfer costs.
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