Arafat Trading Corporation Has Just Acquired A Large Account.

Arafat Trading Corporation has just acquired a large account. As a result, it will soon need an additional Tk. 1,00,000 in working capital. It has been determined that there are three feasible sources of funds

a. Trade credit: The Arafat Trading Corporation buys Tk. 50,000 of materials on terms of 3/30, net 80″.

b. Bank loan: The firm’s bank will loan to. 100.000 at 15% (discount basis) interest. A 10% compensation balance will be required.

C. Factoring: A factoring will buy the company’s receivables (Tk. 1,20,000 per month), which has an average collection period of 30 days. The factoring will advance up to 80% of the face value of the receivable at 12% on an annual basis. It has been estimated that the factoring service will save the company administration cost Tk. 1,500 per month and 1 percent bad debt expense. The factoring also will charge a 2 percent fee on all receivables purchased. Which alternative should Arafat trading corporation select on the basis of annualize percentage cost?

To determine which financing option Arafat Trading Corporation should select, we calculate the Annualized Percentage Cost (Effective Annual Rate) for each alternative.

Alternative (a): Trade Credit

Terms: 3/30, net 80
Discount: 3%
Discount Period: 30 days
Credit Period: 80 days

(Note: Using a 365-day year yields 22.58%).

Alternative (b): Bank Loan

Loan Amount: Tk. 1,00,000
Interest Rate: 15% (Discount basis)
Compensating Balance: 10%

Alternative (c): Factoring

Monthly Receivables: Tk. 1,20,000 Annual Receivables:
Average Advance Balance (80%):

1. Annual Expenses:

Factoring Fee (2%):
Interest on Advance (12%):
Total Gross Annual Cost:

2. Annual Savings:

Admin Costs Saved:
Bad Debt Savings (1%):
Total Annual Savings:

3. Net Cost & Effective Rate:

(If the factoring fee is deducted upfront from usable advance funds, usable funds become , yielding ).

Summary Comparison

Financing Option	Annualized Percentage Cost
a. Trade Credit	22.27%
b. Bank Loan	20.00%
c. Factoring	8.25%

Decision

Arafat Trading Corporation should select Alternative (c) Factoring. At 8.25%, it provides the lowest annualized percentage cost due to substantial savings in administration costs and bad debt expenses

একাডেমিক শিক্ষা বিষয়ক লিখিত প্রশ্ন সমাধান পেতে ক্লিক করুন।