On January 1, Scott Corporation received a $300,000 line of credit at an interest rate of 12% from Main Street Bank and drew down the entire amount on February 1. The line of credit agreement requires that an amount equal to 15% of the loan be deposited into a compensating balance account. What is the effective annual cost of credit for this loan arrangement?
Answer(s): D
Annual interest is $36,000 ($300,000 x 12%), and the amount available is $255,000 [$300,000 - ($300,000 x 15%)]. Thus, the effective interest rate is 14.12% ($36,000 ÷ $255,000).
The Frame Supply Company has just acquired a large account and needs to increase its working capital by $100,000. The controller of the company has identified the four sources of funds given below.1. Pay a factor to buy the company's receivables, which average $125,000 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 10% and charge a fee of 2% on all receivables purchased. The controller estimates that the firm would save $24,000 in collection expenses over the year. Assume the fee and interest are not deductible in advance.2. Borrow $110,000 from a bank at 12% interest A 9% compensating balance would be required.3. Issue $110,000 of 6-month commercial paper to net $100,000 (New paper would be issued every 6 months.)4. Borrow $125,000 from a bank on a discount basis at 20%. No compensating balance would be required.Assume a 360-day year in all of your calculations. Assuming a 360-day year and that CyberAge continues paying on the last day of the credit period, the company's weighted-average annual interest rate for trade credit (ignoring the effects of compounding) for these two vendors is
Answer(s): B
If the company pays Web Master within 10 days, it will save $500 ($25,000 x 2%). Thus, the company is effectively paying $500 to retain $24,500 ($25,000 - $500) for 20 days (30 - 10). The annualized interest rate on this borrowing is 36.7346% [($500 ÷ $24,500) x (360 days ÷ 20 days)]. Similarly, the company is, in effect, paying Softidee $2,500 ($50,000 x 5%) to hold $47,500 ($50,000 - $2,500) for 80 days (90 - 10). The annualized rate on this borrowing is 23.6842% [($2,500 ÷ $47,500) x (360 days ÷ 80 days)]. The average amount borrowed from Web Master is $16,333.33 [$24,500 x 1 month x (20 days ÷ 30 days)], and the average amount borrowed from Softidee is $126,666.67 [$47,500 x 3 months x (80 days ÷ 90 days)]. Thus, the weighted average of these two rates based on average borrowings is 25.2% {[($16,333.33 x 36.7346%) + ($126,666.67 x 23.6842%)] ÷ ($16,333.33 + $126,666.67)}. This calculation, however, understates the true cost of not taking the discount because it does not consider the effects of compounding.
The Frame Supply Company has just acquired a large account and needs to increase its working capital by $100,000. The controller of the company has identified the four sources of funds given below.1. Pay a factor to buy the company's receivables, which average $125,000 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 10% and charge a fee of 2% on all receivables purchased. The controller estimates that the firm would save $24,000 in collection expenses over the year. Assume the fee and interest are not deductible in advance.2. Borrow $110,000 from a bank at 12% interest. A 9% compensating balance would be required.3. Issue $110,000 of 6-month commercial paper to net $100,000. (New paper would be issued every 6 months.)4. Borrow $125,000 from a bank on a discount basis at 20%. No compensating balance would be required.Assume a 360-day year in all of your calculations. Should CyberAge use trade credit and continue paying at the end of the credit period?
The company is currently paying an annual rate of 25.2% (see previous question) to obtain trade credit and pay at the end of the credit period. This policy should be continued if trade credit is the only source of financing, or if other sources are available only at a higher rate.
Gatsby, Inc. is going to begin factoring its accounts receivable and has collected information on the following four finance companies:Which company will give Gatsby the highest proceeds from a $100,000 account due in 60 days? Assume a 360-day year.
Answer(s): A
Company A will withhold $6,000 ($100,000 x 6%) as a reserve against returns and allowances and $1,400 ($100,000 x 14%) as a commission. The remaining $92,600 will be reduced by interest at the rate of 15% annually. The interest charge will be $2,315, assuming a 360-day year [($92,600 x 15) x (60-day payment period - 360 days)). The proceeds to be received by Gatsby equal $90,285 ($92,600 - $2,315).
Hagar Company's bank requires a compensating balance of 20% on a $100,000 loan. If the stated interest on the loan is 7%, what is the effective cost of the loan?
Interest on the loan is $7,000 ($100,000 x 7%). Given that the borrower has to maintain a 20% compensating balance, only $80,000 [$100,000 - ($100,000 x 20%)] is available for use. Thus, the company is paying 4) $7,000 for the use of $80,000 in funds at an effective cost of 8.75% ($7,000 ÷ $80,000).
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