Question

Fujairah Plastic Company is considering pledging its 4 million dirhams of receivables to finance a needed increase in working capital. Rak bank is offering 80% of the pledged receivables at 1.5% points above the prime rate, which is currently 8.5%. In addition, the bank charges a service fee equal to 1% of the pledged receivables. Both interest payments and the service fee are payable at the end of each borrowing period. The company’s average collection period is 60 days, and its receivables are approved by the bank as an acceptable for collateral.

Required?

Compute the amount of usable funds of the company? (3 pts)
What is the annual financing cost? (4 pts)
Suppose that all else remains the same, ADCB bank offers the loan at 9% with a 1.5% service fee. Which alternative source of financing should the company choose? (2 pts)

Answer 1

=>Amount of Usable funds of the company

Pledged receivables - 4 Million

Available Finance Percentage = 80%

Amount = 4 Million * 80% = 3.2 Million

=> Annual Financing Cost

Service Fee - 1%

Rate of Interest = 8.5% + 1.5% = 10%

Total Financing Rate = 10% +1% = 11%

Annual Financing Cost = 11% * 3.2 Mn = 352,000 Dirham

=>Alternative source of Financing from ADCB bank

Service Fee = 1.5%

Rate of Interest = 9%

Total Financing Rate = 10.5%

Annual FInancing Cost with ADCB Bank = 10.5% * 3.2 Mn = 336,000 Dirham

Since the cost is less with ADCB bank, company should choose the option with ADCB bank.