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?

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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

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