Question

Cooley Industries needs an additional $500,000, which it plans to obtain through a factoring arrangement. The factor would purchase Cooley’s accounts receivables and advance the invoice amount, minus a 2 percent commission, on the invoices purchased each month. Cooley sells on terms of net 30 days. In addition, the factor charges a 12 percent annual interest rate on the total invoice amount, to be deducted in advance.

A. What amount of accounts receivable must be factored to net $500,000?

B. If Cooley can reduce credit expenses by $3,500 per month and avoid bad debt losses of 2.5 percent on the factored amount, what is the total dollar cost of the factoring arrangement?

C. What would be the total cost of the factoring arrangement if Cooley’s funding needs rose to $750,000?

D. Would the factoring arrangement be profitable under these circumstances? Assume the conditions described in part b exist.

Accounts receivables needed to factor:				$357,447
Monthly costs:
	Commission			$4,468
	Interest			2,979
	Total monthly costs			$7,447
Monthly savings:
	Credit expense			$5,000
	Bad debt losses			3,574
	Total monthly savings			$8,574
Net monthly savings				$1,128
Net annual savings				$13,532

Answer 1

Given factoring terms are:

Factoring discount = 2%; Annual interest rate = 12% per annum.

a.

Since interest rate is 12% per annum; it can be taken as 1% for the 30 days.

Let x be the gross amount of accounts receivable. Then, Net amount received = x*(1-0.01-0.02) = 0.97X.

If 0.97x = 500,000 (amount required by Cooley)

Therefore gross amount required = 500,000 / 0.97 = 515,464

b.

Expenses saved per month = 3500; and Annual bad debts saving = 581395*2.50% = 14,535.

If factoring costs are 515464 - 500,000 = 15464; and Savings = (3500*12) + 14,535 = 56,535;

Net factoring savings = 56535 - 15464 = 41,071.

c.

In case the amount required is 750,000;

Total gross amount of accounts receivable required = 750000 / 0.97 = 773,196

Factoring savings = 773,196 - 750,000 = 23,196.

Savings due to factoring = (773196 * 2.50% ) + 3500*12= 19330+ 42000 = 61,330.

Hence, net factoring savings = 61330 - 23196 = 38,134.

Therefore, it is a profitable arrangement.

d.

Given that the factoring commission offered would be increased to 2.50%; resulting the interest to reduce to 10.50%.

New gross amount required = 500000 / (1-0.025-(0.1050 / 12))

= 500000 / 0.96625 = 517464. Therefore new factoring cost = 517464 - 500000 = 17464.

Old factoring cost = 15464.

Hence, the old factoring cost was lower compared to new one.