World Telephone & Telegraph (WTT) is considering the establishment of a zero-balance system for its dividend payment account. The firm pays common stockholders quarterly dividends. Currently, WTT deposits the necessary funds to cover the dividend payments on the day the checks are mailed to shareholders. A typical distribution of when the checks clear the dividend account is as follows:
WTT can earn 7.5 percent per annum on any funds released from its dividend payment account using a zero-balance system.
a. Determine the annual pretax returns the firm would earn on the funds released from a zero-balance system.
b. What other considerations need to be examined in making a decision about the desirability of establishing such asystem?