Solved: The Garvin Company is setting up a new checking

account

The Garvin Company is setting up a new checking account with Barngrover National Bank.
Garvin plans to issue checks in the amount of $1.6 million each day and to deduct them from its
own records at the close of business on the day they are written. On average, the bank will
receive and clear (that is, deduct from the firm’s bank balance) the checks at 5 p.m. the fourth
day after they are written. For example, a check written on Monday will be cleared on Friday
afternoon. The firm’s agreement with the bank requires it to maintain a $1.2 million average
compensating balance, which is $400,000 greater than the cash balance the firm would
otherwise have on deposit. Garvin will make a $1.2 million cash deposit at the time it opens the
account.
a. Assuming that the firm makes cash deposits at 2 p.m. each day (and the bank includes them
in that day’s transactions), how much must it deposit daily to maintain a sufficient balance once
it reaches a steady state? (To find the answer, set up a table that shows the daily balance
recorded on the company’s books and the daily balance at the bank until a steady state is
reached.) Indicate the required deposit on Day 1, Day 2, Day 3, Day 4, and each day thereafter,
if any, assuming that the company will write checks for $1.6 million on Day 1 and each day
thereafter.
b. How many days of float does Garvin carry?
c. What ending daily balance should the firm try to maintain (1) on the bank’s records and (2)
on its own records?
d. Explain how net float can help increase the value of the firm’s common stock.

The Garvin Company is setting up a new checking account

ANSWER
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