Question

(Cost of secured short-term credit) The Marlow Sales and Distribution Co. needs $500,000 for the 3-month period ending September 30, 2018. The firm has explored two possible sources of credit. a. Marlow has arranged with its bank for a $500,000 loan secured by its accounts receivable. The bank has agreed to advance Marlow 85 percent of the value of its pledged receivables at a rate of 10 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 $500,000 at a rate of 8 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.

Answer #1

Interest expense = ($1,000,000 - $500,000) x 10% x 85%

= $42,500

Processing fee = $1,750,000 x 1% x 12

= $210,000

APR = (Interest expense + Processing fee) / Credit extended) x
(1 / Time)

= ($42,500 + $210,000) / $500,000) x 1 / 90 / 360

= ($252,500 / $500,000) x 360 / 90

= 2.02 or 202%

Compensating cost = $2,200 x 3 = $6,600

Interest expense = $500,000 x 8% x 3 /12

= $10,000

APR = (Interest expense + Processing fee) / Credit extended) x 1
/ Time

= ($10,000 + $6,600) / $500,000 x 360/90

= 13.28%

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