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A company enters into an agreement with a firm that will factor the company's accounts receivable. The factor agrees to buy the company's receivables, which average $100,000 per month and have an average collection period of 30 days. The factor will advance up to 80% of the face value of receivables at an annual rate of 10% and charge a fee of 2% on all receivables purchased. The controller of the company estimates that the company would save $18,000 in collection expenses over the year. Fees and interest are not deducted in advance. Assuming a 360-day year, what is the annual cost of financing?
Answer (A) is correct.
The first step is to calculate the amount the firm will receive from the factoring transaction:
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Amount of receivables
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$100,000
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Times: Advance percentage
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× 80%
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Amount received
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$ 80,000
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This amount is the basis for the calculation of interest expense:
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Amount advanced
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$ 80,000
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Times: Annual finance charge
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× 10%
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Annualized interest expense
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$ 8,000
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|
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The next step is to calculate the net outlay:
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Amount of receivables
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$100,000
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Times: Factor fee percentage
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× 2%
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Monthly factor fee
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$ 2,000
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Times: Months
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× 12
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Annual factor fee
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$ 24,000
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Less: Annual savings
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(18,000)
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Net outlay
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$ 6,000
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Now the net cost in dollar terms can be determined:
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Annualized interest expense
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$ 8,000
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Net outlay
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6,000
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Annual net cost
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$ 14,000
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As with all financing arrangements, the effective rate is the ratio of the amount the firm must pay to the amount the firm gets use of:
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Effective rate
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=
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Net cost ÷ Usable funds
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=
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$14,000 ÷ $80,000
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=
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17.5%
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TIMUCIN ONER
Director/Manager
ANTALYA
Turkey
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