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%