Question

The Marlow Sales and Distribution Co. needs ​$460,000 for the​ 3-month period ending September​ 30, 2015. The firm has explored two possible sources of credit.

a. Marlow has arranged with its bank for a ​$460,000 loan secured by its accounts receivable. The bank has agreed to advance Marlow 75 percent of the value of its pledged receivables at a rate of 12 percent plus a 1 percent fee based on all receivables pledged.​ Marlow's receivables average a total of​ $1 million​ year-round.

b. An insurance company has agreed to lend the ​$460,000 at a rate of 10 percent per​ annum, using a loan secured by​ Marlow's inventory of salad oil. A​ field-warehouse agreement would be​ used, which would cost Marlow ​$2,200 a month. Which source of credit should Marlow​ select? Explain. Note​: Assume a​ 30-day month and​ 360-day year.

The​ cost, or ​APR, of the pledging accounts receivable, is ___​%.?

The cost or APR of the loan secured by inventory is ____%?

Answer 1

Solution a) The cost of accounts receivables is calculated as:

APR = [(Interest Expense + Processing Fees)/Credit Extended]*(1/time)

Average account receivables = $1 million = $1,000,000

Pledged loan account receivable = 75% of the total receivables

Loan amount = 460,000

Thus, 460,000 = 75%*Pledged account receivable

Pledged account receivable = 460,000/0.75 = $613,333.33

Fees = 1% of the Pledged account receivables = 1%*613,333.33 = $6,133.33

Interest Expense = 12%*Loan amount*1/time = 12%*460,000*3/12 = 55,200*1/4 = $13,800

APR = [(13800 + 6,133.33)/460,000]*(360/90)

APR = (19933.33/460000)*(4)

APR = 0.173333 = 17.33%

Solution b) Cost of loan from insurance company is calculated as:

APR = [(Interest Expense + Processing Fees)/Credit Extended]*(1/time)

Loan Value = $460,000

Interest cost = 10 percent

Agreement cost = 2200 *3 = $6,600

Calculation of Interest Expense = 460,000*10%*3/12 = $11,500

APR = [(11500 + 6600)/460000]*(360/90)

APR = [(11500 + 6600)/460000]*4

APR = 0.039347826*4

APR = 0.157391 = 15.74%

Since the APR of loan is less, hence, option B must be selected.

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